In the world of life insurance, permanent life insurance policies offer a unique combination of protection and financial benefits. Unlike term life insurance which expires after a set period, permanent life insurance remains active for your entire lifetime, providing a guaranteed death benefit to your loved ones whenever you pass away. But with various permanent life insurance options available, choosing the right policy can feel overwhelming. This guide will equip you with the knowledge to confidently compare permanent life insurance policies, ensuring you select the one that aligns perfectly with your financial goals and loved ones' needs.
Selecting the right life insurance policy can seem daunting with the myriad of choices available. It's essential to weigh the costs and benefits of each policy, as well as the reputation of the insurers. The decision between term life insurance, which is temporary, and permanent life insurance, which lasts indefinitely, hinges on your unique needs.
When considering permanent life insurance, it's important to understand the nuances. Policy illustrations can be complex, and varying fees across different insurers make direct comparisons challenging. Here's a simplified guide to help you evaluate life insurance policies.
Key Insights
- Permanent life insurance policies are enduring, providing both a death benefit and a savings component.
- To assess different permanent life policies, consider the internal rate of return (IRR) on the death benefit as a benchmark.
- Typically, the policy with the most favorable IRR would be the optimal choice.
What Is Permanent Life Insurance?
Before diving into comparisons, let's clarify what permanent life insurance entails. Unlike term life insurance, which expires after a set duration, permanent life insurance remains effective indefinitely.
Permanent life insurance typically offers two key advantages: a death benefit, which is the sum paid to beneficiaries upon the insured's passing, and a cash value, which accumulates over time. Policyholders have the flexibility to borrow against this cash value or withdraw from it after a certain period.
Types of Permanent Life Insurance
The market presents mainly two varieties of permanent life insurance policies, both featuring a death benefit and a savings element. The distinction lies in the savings component: whole life insurance policies usually guarantee this part, whereas universal life policies' savings fluctuate with market performance. Universal policies also provide more flexible premium payments. However, it's crucial to maintain premium payments to keep the policy active.
Choosing the right policy involves evaluating the internal rate of return (IRR), a common metric for assessing investments. This measure can guide you in selecting the policy that best suits your financial strategy.
Understanding IRR (Internal Rate of Return)
When choosing a permanent life insurance policy, most people focus on two main aspects: the cost of the premiums and the amount of the death benefit. The objective is to assess the value you get in return for the premiums you pay. This might seem complicated, but there's a straightforward method to make sense of it all: the Internal Rate of Return (IRR) for the death benefit. This tool calculates the interest rate where the present value of what you've paid matches the present value of the benefit your family will receive. Generally, a policy with equal premiums and a higher IRR is considered better.
In the initial years, life insurance typically shows an extremely high IRR, sometimes over 1,000%. This rate decreases as time goes on. The IRR is particularly high at the start because if you were to pass away after paying just one premium, your beneficiaries would still receive the full death benefit.
Note: To get a true sense of a policy's value, you can ask for a report that details the IRR for that policy.
Additional Factors to Consider
When purchasing life insurance, it's advisable to consult with an independent broker who can guide you through the underwriting process and compare different insurers' offerings. Here are some additional points to ponder:
Determining the Death Benefit
The amount of death benefit you need depends on your financial circumstances and the legacy you wish to leave. Take into account your debts, annual income, and other financial obligations. A good rule of thumb is to choose a death benefit that's four to five times your yearly earnings.
Also, consider when the death benefit will be required—upon the first or second death, or both? Often, a survivorship policy covering two individuals offers lower premiums and a higher IRR compared to a policy for just one person.
Age and Health Factors
Insurance companies have varying criteria for their ideal customers and price policies differently based on health conditions. Generally, younger individuals pay lower premiums because insurers expect them to live longer, making older individuals more costly to insure. Premiums will also be higher for smokers or those with serious health conditions.
Choosing an Insurance Company
The financial health and stability of the insurance company are crucial. Selecting a financially troubled company could risk your benefits, so it's important to research the insurer's financial standing.
Deciphering Permanent Life Insurance Choices
When all things are considered equal, like the cost, the payout upon death, and the insurance company's financial health, the policy with the best Internal Rate of Return (IRR) on the death benefit over time is likely the smarter pick. After deciding, you'll need to apply and go through the insurer's evaluation process. Sometimes, the insurer might offer a different rate than expected. If that happens, your insurance advisor can compare offers from other companies to find a better deal.
Risk Allocation
Policies with a guaranteed no-lapse feature have fixed costs and premiums but accumulate minimal cash value. As long as you pay the premium on schedule, the insurer promises to keep the policy active until a certain age. On the other hand, with flexible policies, both you and the insurer share the risk. The premium partly depends on an expected rate of return. A higher expected return means a lower starting premium. But if the returns fall short or the insurer raises fees, you might need to pay more to keep the policy from ending.
Steps Forward
Your next move is to gather quotes from various companies. These quotes, or illustrations, forecast how your policy might perform over time. For accurate comparisons, ensure all quotes:
- Maintain the same premium level or death benefit
- Extend to an agreed-upon age
- Use the same payment frequency—whether it's monthly, quarterly, or yearly
- Apply a uniform expected interest rate for flexible policies
- Leave out any extra-cost options
- Include the IRR report
To assess the quotes:
- Choose between a fixed or flexible death benefit
- Check the insurer's financial ratings
- Identify which policy gives you the highest IRR for the lowest premium