As employers search for ways to create meaningful employee benefits packages, many have turned to life insurance policies. It’s become fairly standard to offer life insurance in the amount of the employee’s annual salary at no cost to the worker. Beyond that, it’s common to offer “buy up” options for employees who might want additional coverage for themselves, or sometimes for a spouse. This could be double, triple, or even five times the amount of a person’s annual salary and in these cases, the premium for extra coverage is typically paid entirely by the employee.
Life Insurance 101: Understanding the Policies
Much like health insurance, life insurance options can be confusing. There are three different types (whole, universal, and term) and even variants among those three. How are people supposed to choose? How do they know which policy is best for their family? We put together a cheat sheet to prepare employees and HR professionals alike to make a more informed decision.
Whole Life Insurance
Whole life insurance is also known as “permanent” life insurance because it lasts throughout the course of a person’s life, regardless of how long they live. There is a guaranteed death benefit, which means that the policy’s benefactors will definitely get a payout upon death of the policyholder (as long as there are no extraneous circumstances outlined in the policy).
Whole life insurance comes with a “cash value” that accumulates as the person ages. As the policyholder pays her monthly premiums, a portion of the money goes to the cash value, while the rest goes toward the death benefit. One of the perks of this benefit is that the policyholder doesn’t have to pay taxes on the accumulated interest.
Policyholders can also borrow from the cash value tax-free, as long as the amount is repaid with interest. The cash value can also be used to pay premiums if the policyholder is unable to pay one month — again, as long as the amount is repaid with interest. In addition, if the policy is canceled at any time, the cash value is awarded to the policyholder, minus any due premiums or penalties.
Interest for the cash value is generally adjusted on an annual basis. Premiums remain the same throughout the life of the policy, although some companies will allow policyholders to choose how long they will make payments. For example, the entire premium can be paid in one lump sum at the beginning of the policy, or over a period of 10, 20 or 30 years.
Universal Life Insurance
Universal life insurance is also considered “permanent” life insurance — again, because it lasts the course of the policyholder’s life. Like whole life insurance, it also comes with a guaranteed death benefit. Universal life insurance policies have the same cash value benefit as whole life policies with the same stipulations in terms of taxes and borrowing, in that you can accumulate interest tax-free, as well as borrow from the cash value tax-free.
One of the major differences with universal life is that the premiums are a bit more flexible. Policyholders can adjust their premiums throughout the course of the policy as financial circumstances change. If a family falls on hard times, they could opt to decrease their premium amount for a period of time and then make up the difference later when things improve.
Policyholders can also access the cash value in order to cover a portion of the premiums as long as they are still paying the minimum balance, otherwise the policy will lapse. However, unlike whole life policies, policyholders can use the accumulated interest to pay premiums over time.
The other major difference between whole and universal life lies in how interest is accumulated on the cash value. If the actual performance of the insurance company’s investments outperforms the stated minimum interest rate on the policy, the cash value can actually earn more than the minimum, making it an attractive option during booming economies. This comes with very little risk, as there’s still a minimum interest percentage.
With the average life expectancy hitting an all time high of 78.8 years, permanent policies may gain popularity — especially since people are graduating college with far more debt than ever before. This generally causes them to put off things that don’t seem particularly urgent, like saving for retirement.
Term Life Insurance
As the name suggests, term life insurance only lasts for a specified amount of time — usually in decade long increments, like 10, 20, or 30 year policies. Term life is specifically intended to supplement income during period of life that might be quite expensive, such as before a home is paid off or while a family is raising children. Losing a partner’s income could be financially devastating to a newly single parent with children to support, so a term policy could be a strong safety net in this case.
Because term life is only for a specified timespan, the cost is considerably less (especially if the policyholder is young and healthy). These policies are truly an in-case-of-emergency type of plan because it’s considered unlikely that a person will die during the term of the policy. For example, if someone in their 30’s purchases a 30 year plan, they are expected to outlive the policy.
Term life also operates under the assumption that people nearing retirement age will have saved up enough money to cover their final death expenses, as well as paid off all major debts (such as a house and student loans) and therefore, will not need a substantial death benefit.
The other major difference with term life policies is that they do not include a cash value, since eventually, all these policies would end and then the insurance company would have to pay out large sums of money even when no one has passed away. In addition, one of the reasons term policies come with lower premiums is precisely because there isn’t a cash value stocked away.
For those who are enrolled in the standard employee-sponsored life insurance policies, they are most likely term policies, since they are only valid for the period of time in which the policyholder works for the company and would not carry over into retirement. Additionally, if employees plan to purchase a “buy-up” plan, doing so during open enrollment can save them loads of paperwork, as well as possible evidence of insurability, like a questionnaire or a physical. Furthermore, some policies purchased outside of open enrollment come at a higher cost for those who have a history of health problems.
Which Policy is Best?
Determining which type of life insurance is “best” for anyone is similar to choosing the “best” health insurance plan: it’s really based upon what a person can afford and what they will need the death benefit (or the cash value) to pay for. For example, someone with very little savings (or structure to save) may want to purchase whole or universal coverage because — well, dying isn’t free.
Funerals and cremation are both expensive. The average cost of a traditional funeral (with a burial and headstone) is between $8,000 and $10,000. Of course, this price can vary and be far higher if an expensive casket is purchased or a reception with refreshments is thrown at some point. While cremation may be “cheaper,” it’s still a large amount of money, ranging from $1,500 for simple cremation to $6,000 at a funeral home with services.
In addition, some wealthy people choose to purchase permanent insurance to help cover estate taxes when their assets transfers to their benefactors, although this won’t apply to the majority of Americans, as the estate filing threshold is $5.49 million for 2017.
Other, less wealthy individuals choose permanent coverage so that survivors have enough money to pay any large-scale medical bills incurred at the end of life. This is common for people who have chronic illnesses that may require more attention as the person ages — although their premiums may be higher than a “healthy” person.
However, most people choose term life — in part because it’s cheaper and in part because they assume that by the time they die, their major debts will be paid off and their savings or leftover retirement will be able to cover the cost of their final burial. This is, of course, assuming they’ll be fortunate enough to properly save for retirement.
Life Insurance is for Survivors
The bottom line is that life insurance isn’t meant for the policyholder. While whole and universal life policies carry cash values that can be borrowed against, their main purpose is to provide survivors with death benefits to cover final expenses and taxes — or perhaps help them transition after the loss of a family member’s income.
This means that life insurance 101 is really about assessing the needs of those that will be left behind. Will they need help paying for a funeral? Will they need help paying for the kids’ college educations? Is there enough money saved to cover the balance on the mortgage, the car, and any loans? All of these are important questions every adult must ask themselves when choosing a life insurance policy.
We’re here to help you figure this out! What questions do you still have about life insurance? Leave us a comment below or contact us.
The JP Griffin Group consults for discerning companies coast-to-coast, ranging in size from 10 to more than 30,000 employees. In addition to our Scottsdale, Arizona headquarters, we have bi coastal offices in Seattle, WA and Washington, DC.