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Taking Care of Mom and Dad: Types of Life Insurance

You and your parents are probably familiar with the basic kinds of life insurance. But it's worth reviewing the general types.

Term life insurance -- which has no value after a set period of time (its term) -- is the most common and cheapest form of coverage. It's the kind of life insurance you see advertised on late-night television and scores of Web sites across the Internet.

Your parents won't want to buy a term policy if they're in their 60s or older. Age is a major factor in the pricing of term coverage and a term policy's price advantage fades considerably as the insured person get older.

Example: Your mother, who's 62 and healthy, gets a reason-ably-priced term life insurance policy for $100,000 that lasts 10 years. Ten years later, she's still in good health -- but replacing the $100,000 policy could cost two or three times what it did before...if she can get one at all. (And this assumes, she's still in good health.)

Beyond term policies, there are some forms of life insurance that build cash value or equity over time. And these are of more value to your parents when they are older. Cash value policies include:

  • whole life;
  • universal life;
  • blended whole/universal life;
  • interest sensitive whole life;
  • variable life;
  • variable universal life; and
  • variable blended whole/universal life.

In most cases, cash value premiums start higher than term premiums; but they stay level...and the policy accumulates a redeemable equity as time goes on. Once commissions and expenses to the policy are paid, the cash value of the policy increases over the long haul, thus making the long-term investment in a policy key.

A cash value policy makes sense if your parents:

  • are accumulating cash for the future;
  • need coverage for more than 15 years;
  • are in a high tax bracket; or
  • were over 35 when they bought their first policy.

The most common of these kinds of insurance is whole life. Whole life insurance is a permanent form of insurance protection that combines a death benefit with cash value accumulations. In a whole life policy, the face amount -- the amount paid if the insured person dies at any time while the policy is in effect -- remains constant.

At retirement, many people use the accumulated cash value in a whole life policy to supplement retirement income. This gradually reduces the death benefit. So, if your dad retired last year and has started to use his whole life policy to add to his fixed income, the amount his policy pays when he dies will depend on how long he lives and how much he takes out from the policy.

Whole life is preferred to other kinds of life insurance by most people because it combines protection and savings -- two major factors in the financial plans of most families.

In addition to the death benefit or eventual return of cash value, a whole life policy has some other significant features. During a financial emergency, policy loans may be available. Some whole life policies also pay dividends.

The policy owner also has options as to how dividends will be received. They can be taken in cash or applied toward premium payments. They can also be held by the insurance company and earn interest -- and then be transferred later. Finally, they may also be used to buy additional amounts of life insurance.

After a whole life policy has a cash value, certain values are guaranteed upon the lapse or surrender of the policy. Any of these options (which are known as nonforfeiture options) may be used to pay premiums and keep the policy in force.

Another common form of cash value coverage is universal life. With this kind of policy, your parents can pay premiums at any time, of virtually any amount. The amount of cash value the policy builds is based both on the premiums paid and on the interest earned. The insurance company subtracts money from the policy each month to cover the cost of the insurance and expenses.

While universal life policies build cash value, they seek to compete in the term insurance marketplace. They offer standard rates that can be substantially cheaper -- as much as 30 percent or more -- than standard rates charged by insurance companies for comparable term coverage.

Some universal life policies feature progressive underwriting (which means it's easier to get coverage, even if your parents don't look insurable on paper). These policies usually are structured so that if your parents pay minimum annual premiums, coverage won't lapse for 15 or 20 years.

Another form of this insurance is variable universal life. It provides death benefits and cash values that vary according to the investment returns of stock and bond funds managed by the life insurance company. These policies also allow your parents significant discretion regarding the premiums paid each year.

For many people, variable universal life is as much an investment tool as a true insurance tool.

Target premiums are fixed in the first year -- but policyholders, because of the flexible nature of the products, are not contractually entitled to those amounts in subsequent years. In fact, target premiums for variable universal life insurance are among the highest in the industry. This is why marketers sell variable universal so aggressively -- because their commissions are often based on target premiums, so they can make more selling this than any other kind of life insurance.

In some cases, the cost basis of variable universal life becomes too uncertain for most people because of the open-ended method of premium payment.

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