Life Insurance

Types and Explanations

Term Life insurance is the least complex and least expensive type of life insurance. Term life is simply what it says that it is, it is life insurance purchased for a particular time period, or term. Most other policies have what is called a cash value, which means that if you cancel the policy you are entitled to receive some funds back from the insurance policy. Term life has no cash value; it simply has what is called a death benefit. If you purchase a $25,000 term life insurance policy and you die, your heirs will receive $25,000. Typically, term insurance is the type of insurance that you see advertised as it is generally, the cheapest form of life insurance.

Universal Life is insurance that offers the most flexibility of all permanent (as opposed to term) policies that carry a cash value. Similar to Term Life, it has a death benefit, but also offers a rate of return on the premiums you pay for coverage. Consequently it is more expensive up-front. Another advantage of this type of policy is that the accumulation of cash is tax deferred. You usually earn close to market rates on the amount of cash value in the policy. Additionally, under certain circumstances, one can borrow portions of the accumulated growth of the account within the policy and not incur tax liability on the funds borrowed. One downside of Universal Life, as opposed to a Variable Life policy (see below) is that you simply have one account into which your funds are invested; you do not have the ability to move funds from one account to another within the policy.

Variable Universal Life is a type of permanent coverage similar to Universal Life, thus many of the benefits are the same. The policy is called Variable because the policy holder has the right to move funds from one investment account to another inside of the policy, for example, from stock funds to bond funds or money market accounts. One downside of Variable Universal Life as compared to standard Universal Life is the fact that because there are multiple accounts, the policyholder is responsible for managing the funds within the policy. Tuition Funding Solutions Financial Services offers professional and continual guidance with such decisions in order to help maximize your return on the policy and/or the benefit that accrues to your heirs.

Whole Life is the oldest version of life insurance. This does not mean it is outdated; it is simply a different version. In a whole life policy, the owner will have life insurance as to the amount purchased. Additionally, a portion of the premium will develop a cash value within the policy, similar to Universal life. One variance is that the insurance company determines how premiums are invested, not the owner of the policy. As such, you have less flexibility than in a Universal Life policy. The cash value tends to grow at a lower rate; however the investments are very low risk investments. A significant advantage is that regardless of age, the premium payments cannot increase. Another advantage is that as your cash value receives dividends, you can elect to receive those dividends or leave them in the policy to lower your future premium payments. Finally, you can keep making the premium payments and allow your dividends to return more interest.

Beyond this short list, there are many permutations and variances. Tuition Funding Solutions Financial Services is here to walk you through this complicated maze and to assist you with making the best decision to accomplish your unique goals.

Annuities

An annuity, in its most basic sense, is created by an individual and an insurance company agreeing that based on the amount the individual places in the account, the insurance company will pay back to the individual a series of specific payments. The income growth in all annuities is tax deferred until it is received by the individual, the "annuitant." As is the case with any tax deferred account, if there is an early withdraw of funds a penalty will also have to be paid.

A more detailed definition would call this relationship a contract that an insurance company sells to an individual so that payments can be made in predetermined payments to the individual. The most common usage of annuities is for retirement. As with all contracts supplied by insurance companies, each insurance company is regulated by the insurance commissioner in the state where the insurance company is incorporated.

There exists a wide range of annuity accounts. The below list is not meant to be exhaustive but simply an overview of the most common types of annuities. We have arranged annuities into three categories, Fixed, Variable, then annuity scenarios that can be used with either fixed or variable.

Fixed Annuity

First let's look at a fixed annuity. A fixed annuity is one in which the principal and an interest rate is guaranteed to the investor from the insurance company. Quite often, insurance companies will guarantee a minimum payment or minimum interest rate for as long as the annuity remains in force. If the annuity outperforms what the insurance company predicted, and its board of director's chooses to do so, the payments might increase. However, the payments can never decrease below the payment stated in the contract.

There are two primary subsets of a fixed annuity. One is called a Market Value Adjusted annuity. This is a nice variation from the standard fixed annuity as it allows the investor to decide the time period in which the investment will grow and the start date of return. This process is basically simple math, one looks at the initial investment, the time for the principal to grow at the pre-established rate and the payment term leaving one with the payment amount. These annuities are tremendously complex please do not progress until you have a conversation with someone from our team.

The second subset is called an Equity Indexed Annuity. Think of it as the Toyota Prius of cars. It runs off of gas, but sometimes you can save some money by using electric. In this situation, the fixed annuity still has a minimum interest rate, but with an upside. The upside is that the value of the annuity is based on a percentage of the return of a specific stock index. In this manner, if the stock index drops, a minimum annual return may be guaranteed. If however, the stock index outperforms the minimum interest rate, the investor receives the higher rate.

Variable Annuity

So if the first annuity is fixed the second should be variable. A variable annuity has the same basic characteristics as a fixed annuity except that the funds are invested in a manner similar to mutual funds, but specific only to the insurance company's variable annuity and variable life insurance clients. Most variable annuity funds have multiple options on how to invest, again attempting to be sensitive to the investor's comfort for risk and need for return. A difference between a fixed and variable annuity is that with a variable annuity, the payments are determined by the return on the fund with no minimum payment. On the bright side, the investor receives all of the net gain of the underlying funds in the policy. Because of this added risk, this type of investment is highly regulated.

Annuities that can be Fixed or Variable

As a quick overview there are four primary types of annuities that can be based on the foundation of other Fixed or Variable. The differences between these annuity types are based on how premiums are paid, how the annuity is liquidated and whether or not the annuity's growth is tax deferred.

First one needs to decide how payments and premiums are going to be made. Deferred annuities accept payments and income wherein the payback will not be until some future date. The most common application of this type of annuity is when it is used for retirement. The opposite type of annuity is what is called an immediate annuity. Within this annuity are two primary subsets. For example one can make x number of payments into the annuity and then the first month after those payments end, repayment begins. This annuity is often used when retirement is certain to be in 60 months, (just an example), the owner of the annuity makes 60 payments, then on the 61st month begins receiving monthly payments back until the annuity is liquidated. The other subset is when the investor deposits a large lump sum into the annuity and then receives immediate repayments until the annuity is liquidated. An example would be if an estate pays you $100,000, you can invest the $100,000 in an annuity and then begin receiving monthly payments of principal and interest from the annuity.

The second set of variances requires the investor to determine if the repayment to the investor is going to occur over a set period of months or for the investor's life, regardless of age. The first option is called a Fixed Period. The fixed period and the contribution into the annuity are the first two questions to be asked. The insurance company then determines what interest rate that it can guarantee; finally the monthly repayment amount is established. The second option is called a Lifetime annuity as it guarantees repayments, based on actuary tables. Thus if you exceed your expected lifespan payments will cease before your death. As this option caused much concern insurance companies have added a guaranteed period, basically an insurance that guarantees the annuity payments until an agreed upon time post the actuarial lifespan. If you happen to die earlier your beneficiaries will continue to receive payments until the end of the guaranteed period.

The third set of variances relate as to how the premium for the annuity is paid. To some degree this is already covered but in most contracts it is a separate itemization for clarification purposes. There are two ways to pay the premium for an annuity; the first is called a Single Premium. As the name implies you pay one premium and the repayments are paid back as designed in the contract. An example would be an inheritance, rollover from another account, sale of a monetarily large asset, winning the lottery, a large bonus, etc., you invest a single premium to be paid back with interest at a later date. The second option is called Flexible Premium. Again the term defines itself; the investor invests into the annuity of a series of payments until a time when the annuity has grown to such a point wherein the investor wants repayments. All flexible premium annuities are deferred annuities, as time needs to pass for the interest to accrue.

The final set of variances that will be discussed is qualified versus nonqualified annuities. A qualified annuity is one that sits inside of a retirement account, allowing the interest to grow without interest being paid until the investor retires. If the investor desires to take the money out of the annuity prior to the age required by the retirement account, all penalties and income tax rules that relate to that retirement account will be in full effect. The opposite is a nonqualified annuity which is simply an annuity that is not related to a retirement account. All interest accumulated is still tax deferred until the time that the payments begin to be taken out of the annuity account.