Pros and cons of common life insurance strategies

Information courtesy of USAA Life Insurance Company and USAA Life Insurance Company of New York

A common question people have about life insurance is what type they should think about buying: permanent or term. Let's review some common approaches, so you can determine which is best for you and your family.

To compare strategies, let's look at some common elements of each:

• How long coverage lasts
• How much coverage costs
• Risks of the strategy

"Buy term and invest the rest."

This approach says that you can do better with investments than a permanent insurance policy. Given a length of time like 30 years, you may not need life insurance as a financial safeguard. Advocates of this approach highlight the low cost of term insurance and double-digit investment returns. While these statements can be true, they aren't without trade-offs.

Pro

• Term life insurance costs less than permanent. A $500,000 term policy may cost $25 a month, where the same amount of whole life could cost $150 a month.
• Assuming you can save monthly, the cost of your term insurance shouldn't impact the long-term growth of your money.
• Term insurance policies typically don't have a surrender charge or penalty for termination. You can adjust or cancel your coverage without cost if you believe you no longer need life insurance.

Con

• Investment returns and markets can be unpredictable, and managing risks to your savings can take time.
• If you're behind the curve for retirement savings, you may have to save more or invest more aggressively. This may not be ideal, depending on your budget and risk tolerance.
• You may need discipline to keep to your strategy. Emergencies or life changes can disrupt your savings. This can be more challenging if your income sources vary month to month.

Term insurance typically maintains the premium and coverage amounts during the term period, up to 30 years. After that, the benefit reduces every year or the premium increases every year, making the policy expensive.

Statistically, you'll outlive the term. This isn't a con, but it's a trade-off to the strategy. If you haven't met your savings goals your loved ones may still need a safety net should your term guarantee period end.

This strategy is best if you can comfortably invest and are confident you can meet your financial goals. You'll need to be able to pay off debts and have funds for anyone financially dependent on you. The biggest risk is that you'll outlive your term insurance guarantee period and not have enough saved.

Most term insurance policies offer a conversion privilege. This allows you to exchange all or a portion of your term policy for a permanent policy without having to go through medical underwriting. You have the option to continue coverage beyond your term without having to start the shopping process from scratch.

Note to owners: If you're reconsidering your strategy, review your contract for conversion options or other features that can help you adjust your insurance. Canceling a term policy is straightforward and most of the time without cost or penalty. Make sure your new strategy or policy is in place before canceling any existing life insurance.

Use cash value insurance as your own bank.

There's a financial concept that involves using whole life policies that pay dividends in order to grow the cash value, pay for policy premiums and offer a resource that policyholders can borrow from on a tax-preferred basis. Sounds great, right? So, what's the trade-off? First and foremost, the price of admission is often out of reach for many Americans. As we said before, the average whole life policy can have a monthly premium that runs multiple times the price of a term policy for the same amount of coverage.

Let's consider the advantages and disadvantages:

A whole life policy with guaranteed rates has a fixed premium, a fixed cash value interest rate and possibly a dividend rate payable to the policyholder.

The strategy suggests you use your potential dividends and interest to build up the cash value. You can update how you use your dividend during the policy's lifetime. This is a bit technical but important to understand the trade-offs and risks.

The idea is that your policy will grow in cash value enough for the dividend and interest earnings to pay for the policy premium. You use the dividends to offset your out-of-pocket costs to keep the policy in place. This is where the strategy gets even more technical. Cash value life insurance policies typically allow you to borrow or withdraw money from your cash value. Assuming the policy remains in force, the cash you borrow or withdraw should not increase your income tax liabilities. But the amount of loans or withdrawals from the policy could reduce the death benefit paid to your loved ones when you pass away.

In effect, advocates of this strategy say that your life insurance becomes a lender of sorts and creates an additional tax shelter for retirement income resources.

Pro

• Potential for cash value growth based on the factors within the policy.
• A policy that'll last your entire lifetime, assuming you pay your premiums.
• Flexible resource for many uses depending on the policy type and provisions.

Con

• Expensive to implement and potentially unaffordable for many Americans.
• Policy interest rates are at the discretion of the insurance company and can increase or decrease.
• The insurance company must declare dividends and does not guarantee them.
• Typically, with cash value life insurance policies, surrender fees and policy expenses are high. You should consider them as part of your shopping and planning process.
• If you don't pay your premiums and the policy lapses or terminates with an outstanding loan or withdrawal, you may incur a tax liability.

Note to owners: If you're reconsidering your permanent insurance policy, review your contract of details regarding surrendering your policy. Permanent insurance can carry long windows of time in which you may pay a penalty for cancellation. Alternatively, there may be nonforfeiture options within your contract that allow you different paths to consider. Speak with your insurance provider's policy service group to learn more about your options before canceling coverage. You may also want to take steps to have replacement coverage in place, so you aren't going without life insurance.

Combination of term and permanent insurance

A popular strategy is to protect the majority of your life insurance needs with term life insurance. It could help pay for things like your mortgage or provide a financial safety net for your children for a specific period.

Financially, this makes sense because your biggest immediate needs for insurance are things that likely will reduce or go away over time. The two most notable needs are replacing your income and paying off debts like a home loan. Over the next 20 to 30 years, children will grow up and become financially independent. Mortgages will be paid off. And you'll hopefully have saved for your own financial independence in retirement. The temporary needs that you may have today, protected by a 20- to 30-year term policy, will most likely not be permanent needs.

Having a combination of term insurance and permanent insurance can create a stair step approach. You have more insurance when your needs are greater and a plan in place to reduce your coverage to adjust to the needs of your future. Future needs can be hard to predict, but it may be beneficial for your financial situation to have some coverage in place for shortfalls in future costs like health care, long-term care or retirement income for your survivors. You may also have goals that you want life insurance to support, like leaving a legacy to children or grandchildren or to offset funeral and final expenses. The combination strategy helps take care of future matters without having to make decisions on life insurance when you're older and health or lifestyle has changed.

Pro

• It's not as costly as using permanent insurance for all your insurance needs.
• Term insurance policies typically have conversion privileges so you can adjust your permanent insurance mix over time or as needs change.
• Beginning the permanent insurance policy sooner will likely increase the accumulated cash value, which can provide more options in the future.

Con

• It's more expensive than term insurance by itself.
• Cash value accumulation within the permanent policy will vary based on product type and rates determined by the insurance company.

Note to owners: If you're thinking of surrendering your permanent insurance policy, review your contract details first. Permanent insurance can carry long windows of time which you could pay a penalty for canceling. Alternatively, there may be nonforfeiture options within your contract that you may want to consider. Speak with your insurance provider's policy service group to learn more before making a move. You should also take steps to have replacement coverage in place so you aren't going without life insurance.

Conclusion

Remember the reason you want life insurance in the first place. You love someone who's financially dependent on you.

No matter the strategy you pick, make sure that's your priority.

Because life insurance can be versatile and complex, there are pros and cons you need to consider. But you're not in this decision alone. USAA has a dedicated team of life insurance specialists who are here to help.