1.  It might be more coverage than you need… or at least coverage for longer than you need.  Because permanent life insurance is so much more expensive than term life insurance, people might get a lower face value than they really need, but end up with life insurance long after their children are grown and the house is paid off.  It usually makes more sense to purchase a less expensive, higher face value term policy, which will truly provide financial protection to your family while they need it – ie, while children are young, college still has to be funded, and payments are still being made on the house.

2.  It may not be your best investment.  The idea with permanent life insurance is that it provides a death benefit, but also builds cash value via investments.  But for most people, it makes more sense to purchase insurance separately from investments.  It’s hard to tell where your money is being invested in a permanent life insurance policy.

3.  But in rare cases, it’s just the ticket.  I would say that these are very rare cases, but they do happen.

4.  The right flavor makes all the difference.  Deciding among the three types of permanent life insurance policies (universal, variable, and whole) will likely require extensive research and/or a meeting with a financial advisor.

5.  Dumping a policy will cost you.  It takes many years for the cash value in permanent life insurance policies to build up to a significant amount of money.  If you cancel a term policy early, you’ve only paid for the life insurance protection you got during the years you had the policy.  But if you cancel a permanent policy in the first 10 or 15 years, you will likely have paid a lot of money (above and beyond what you would have paid for just having the death benefit of a term policy) and get very little in return.  A permanent policy is really only appropriate if you know that you’ll stick with the policy for the long term.

Permanent life insurance is a good option for some people.  But if you choose to purchase it, make sure that your decision is based on independent research or advice from a qualified professional who does not have a vested interest in your decision.  The premiums – and thus the commissions – are significantly higher on permanent life insurance policies; if the person advising you to opt for a permanent policy is also making a commission based on the policy you buy, you might want to get a second opinion.

Determining whether return of premium life insurance is a good choice depends a lot on your own habits, goals, and tolerance for risk. Let’s consider a hypothetical situation of a 35 year old female who is looking for a $1 million, 30 year term policy. Let’s say she can purchase a traditional term policy for $650/year, or a return of premium policy for $1175/year.

If she buys the traditional term policy, she will spend $19,500 on the coverage over the course of 30 years ($650 x 30). This money is gone forever, but it has done its job of purchasing peace of mind for her and her family.

If she buys the return of premium policy, she will spend $35,250 on the coverage ($1175 x 30), but if she is alive at the end of the 30 year term, she will get the entire amount back. This option costs a total of $15,750 more than the traditional term policy, so the trade off between the two policies is what she could have done with that money if she had purchased the traditional policy instead.

Here’s where an investment calculator comes in handy. The return of premium policy will cost $525 more per year than the traditional term policy. We can use an investment calculator to determine what sort of return she would have to get on that money if she invested it on her own, in order to end up with at least a total of $35,250 at the end of 30 years (since that’s the amount she will end up with if she buys the return of premium policy).

There are numerous online investment calculators that you can use. Each person’s situation will be different in terms of taxes (ie, one person might choose to invest the difference between the premiums in a traditional IRA, with tax-deferred growth, while another person might put the money into a taxable brokerage account) so I’m focusing solely on the growth of the money without taking taxes into consideration. Here is an example of a simple calculator that you can use to determine the effective rate of return that the return of premium policy is giving you.  For our hypothetical lady, we can input 30 years, an initial principal of zero dollars, and an annual investment of $525.  We can reduce the tax rate to 0%, but if she is investing her money in a taxable account, that amount will have to be increased.  Then we can move the little blue arrow on the rate of return line until the investment total (in blue at the top of the calculator) gets to at least $35,250.  For our lady, this happens at 4.8%, at which point, her investment would be worth $35,324 after 30 years (if she invested her money in a taxable account, her rate of return would have to be higher to offset the loss to taxes).

So if this lady were to get average returns of more than 4.8% in another investment vehicle, she would be better off getting the traditional term policy.  But if she likes the idea of a guaranteed rate of return and forced savings, she might be better off with the return of premium policy.  The final decision will be up to you, but understanding the numbers behind the premiums will likely make the decision easier.

But what about life insurance?  66% of Americans get their life insurance through an employer.  It’s typically inexpensive, just a few dollars per paycheck, or in some cases completely funded by the employer.  But for a person who gets laid off, life insurance is often just one more thing to add to the list of benefits that are lost in addition to the job.

Basic term life insurance is much less expensive than health insurance, but it might not be something that a family thinks about in the face of a job loss.  Unfortunately, that leaves a family – that might already be facing some of their most trying economic times – with much more potential financial risk.

It is possible to continue group life insurance under COBRA, but I don’t think it’s an option that most people know about.  And while individual life insurance premiums are quite low, it’s easy to procrastinate on the application process.  Although most Americans understand the importance of life insurance, it might be pretty far down on the list of priorities in the event of an unplanned job loss.   Here in Colorado, unemployment reached 6.1% in December – the highest in five years.  And nationwide, job loss numbers are not encouraging.  While it’s not particularly enjoyable to think about being laid off, it’s a good idea to think of the benefits your job includes, and get an idea of the options that are available for continuing or recreating those benefits on your own if necessary.

We analyze a client’s life insurance requirements using either an income replacement method, or a needs fulfillment method, or both. We also combine this with a clients individual budget for life insurance to determine what type, and how much Colorado life insurance the client requires. The income replacement method of a needs analysis is to determine how much life insurance is required if the purpose is to replace the income that your family would require to survive. The needs fulfillment method determines how much life insurance is needed to cover future family needs like paying off debts and mortgages, saving for college, etc.

A universal life insurance policy is more flexible and less expensive than a whole life insurance policy, but the interest rates have lower guarantees. Premiums may be increased or decreased by the policyholder within policy limits in order to change the policy as needs change. The amount of life insurance may be increased, subject to evidence of insurability, or decreased subject to minimums set by each Colorado life insurance company. Loans can be taken from the policy once it has gained a cash value, but can reduce the cash surrender value and death benefit. Withdrawals may also be taken but can also reduce the cash surrender value and death benefit.

An Easy Long Term Solution

A whole life insurance policy pays out its face value whenever you die. In the early years of a whole life policy, the premiums are much higher than the customer would pay with a term life insurance policy. These up-front overpayments are what keep the later payments reasonable. Otherwise, as you grow older, your premiums would need to increase substantially to keep up with the risk of insuring you. Level Premium Whole Life policies require premiums to be paid your whole life. Limited-pay whole life policies require higher payments for only a few years.

Are you getting a good deal with whole life?

- Probably not. Check out a good analysis by Moolanomy. It also has a comment that sums up my feelings on whole life:

Whole life is a huge rip off for most people. Stick to a combination of a strong savings plan and fixed term life insurance. If 30 years from now you need a large death benefit you’ve done something wrong along the way.
Estate planning does have some use for whole life style policies but most people won’t have an estate that is large enough to need to duck the estate tax and gift tax laws.

A term life policy pays out its face value only if you die during the selected term. Normally, if you have not used the death benefit when the term runs out, the policy expires. However, return of premium policies are becoming very popular as an alternative to typical term life insurance and even whole life and universal life policies. Building cash value with a permanent policy means paying high premiums (2 to 3 times as much for the same coverage). While an unused term policy can feel like a waste. Return of Premium (ROP) term is an easy and effective new solution that splits the problem down the middle. It starts out like term life insurance with one extra promise from the carrier: If you pay your premiums and you live, we’ll give you your money back. On a normal 20 year level term Colorado life insurance policy the ROP benefit may cost about 30% more, but that extra premium will effectively earn you a 6-7% return over the 20 years — just enough to earn you back everything you’ve invested. What’s in it for the life insurance company? Your loyalty. Colorado life insurance companies spend a lot of money to get your business, and only start making a profit if you stick around more than five years or so. ROP gives an incentive for their customers to stay for the full term. And, for those that don’t, the carrier made an extra 30% on those guys — and used some of it to pay you a solid return on your money for sticking around and living. So if you know that you are going to be insured for the entire term, then think about paying a little more for the ROP benefit and getting it all back in the end. We would be happy to give you the price of a term life policy and compare it with the same amount of ROP term and do the math to see if ROP term would be a good investment.