A while back, I had an opportunity to spend a month in the Catskills with friends. One brisk Saturday afternoon we decided to go hiking on one of the many trails—if you ever get the chance to visit the Catskills, I highly recommend it. Halfway up the trail, we stopped to watch a few folks precariously climbing around a beautiful waterfall (see photo and notice the 2 people standing near the bottom). It was a sight to see and I got close enough to bask in the negative ions produced by the rushing water—but not that close.
Putting on my financial planning hat, I had to wonder: Don't these hikers realize all the mist and moss that is causing the rocks to be slippery? Are they experienced hikers? Are they wearing the right footwear? Do they understand the risks they are taking? If something happened to them, would their families and loved ones have financial safeguards in place?
This experience inspired me to write about an often overlooked topic: Life insurance. To begin, let's take a look at the primary differences between term and permanent life insurance and share some planning strategies to consider.
Term and permanent life insurance
As the name implies, term life provides coverage for a specific "term," or period of time (e.g., 10, 20, or 30 years). Term is generally the most affordable type of life insurance. It usually allows clients to obtain the highest amount of coverage for the lowest initial premium. Most people purchase term to cover needs that are anticipated to go away over time, such as a home mortgage or for the expense of raising children through their college years. Most term policies also offer an option, after the selected time period, to continue the policy if circumstances change, but the premiums tend to be prohibitively expensive.
Most term policies have level premiums, meaning that premiums will remain the same for the duration of the selected level term period. There is also a type called "annual renewable term." With these, essentially the policy is renewed on an annual basis. Annual renewable policies begin with a lower premium; however, the premium gradually increases each year, reflecting the greater risk of death as we age. Annual renewable term policies are generally more appropriate when the need is for a short period of time, say, less than 5 years.
Term policies are designed to provide coverage for a set period of time, not for a lifetime. If you outlive the term period and decide not to continue coverage, the policy expires—leaving your heirs with no death benefit coverage.
What about group coverage at your workplace?
Many individuals, including myself, obtain life insurance through employer-sponsored plans as part of their benefits package. It may come at a higher cost than you think. While group insurance typically allows coverage with minimal or no medical underwriting, you are generally limited to the type of policy and carrier. Further, you might pay the same premium regardless of your health. Most individual policies are medically underwritten, so a healthy nonsmoker is likely to have a lower premium than a smoker and a cancer survivor may have a higher premium than others who have been cancer-free. Such personalization is often not available with group plans.
Moreover, group coverage often has low set coverage amounts and even additional insurance that may be available will be subject to set plan limits. Group coverage is beneficial but has its limitations. Bottom line: Don't assume group insurance is the most efficient coverage. Review the plan offering against individual needs and circumstances. Finally, group insurance is typically only in force while you remain employed with the employer. Some plans may allow you to own the insurance individually after your employment ends, but it is typically more expensive.
While term insurance covers a certain period of time, permanent life insurance provides coverage for "life." Remember though, while intended to provide lifetime coverage, the longevity of a policy is dependent on numerous factors, including product design, premiums, and performance. What's more, not every life insurance company evaluates particular risk factors in the same way. It makes sense to review coverage options on an annual basis to help ensure the policy is performing as expected.
Permanent policies also typically build equity called "cash value" that accumulates tax-deferred, which makes the policies more expensive. Look to permanent coverage when there will be a need for insurance regardless of when death may occur (i.e., to cover estate taxes).
Converting term life insurance to a permanent policy
Many term policies contain a conversion option or "rider," which allows policyowners to convert their term policy into a permanent policy without having to provide evidence of insurability, such as undergoing a new medical exam.
Insurance companies each have their own ways of handling term-to-permanent conversions, so it's helpful to take the time to review all available options, especially if your medical condition has changed since your current policy was written. Most importantly, remember that most insurance carriers will limit the time frame in which they will allow a policyowner to convert.
We recently worked with a client who was diagnosed with a life-threatening medical condition that made new insurance virtually impossible to obtain. However, there was still a need for life insurance. Thankfully, the client had obtained term insurance many years ago. As the conversion option was still in effect, he was able to maintain coverage for himself and his family.
Using a ladder strategy for term life insurance
Just as some fixed income investors "ladder" their bonds or CDs with varying terms to maturity, laddering term life insurance can provide policyholders with flexibility to accommodate changing needs. Multiple policies with varying terms and coverage are purchased. This helps maintain only what is necessary and may reduce unnecessary life insurance premium expenses for those with a clear timeline for their planning needs.
For example, if someone has a house with a 30-year mortgage and children who will be completing college within 10 years, they could purchase a 30-year term policy to cover the entire mortgage and college costs. Alternatively, they could purchase a 10-year term policy to cover the costs of the children's tuition and a 30-year term policy to cover the amount of the mortgage.
Review all available options and costs to determine the most appropriate approach to accomplish your goals. Designs are not one-size-fits-all and specific circumstances must be considered when determining the strategy that makes sense for you.
For many people, life insurance can help manage risk, replace wealth lost to estate taxes, and be used as a non-correlated, tax-advantaged investment vehicle. Since the COVID pandemic, the requirement of in-person physical exams as part of the medical underwriting process has evolved. Even if you haven't considered life insurance options as part of a holistic financial plan, it may be time to revisit this topic and reach out to your Fidelity financial professional to explore further.
Once again, I give the Catskills a "thumbs-up" and hope to see you on one of the trails. If we meet, I promise I am fun to go hiking with and won't burden you with questions of whether you are adequately insured!
David is responsible for Fidelity's estate and wealth planning activities, including creation of new thought leadership in these areas. He heads a team of professionals that develops and delivers the depth and breadth of Fidelity's wealth planning offering.
Prior to joining Fidelity, David was managing director and head of Insured Solutions for UBS Wealth Management Americas. He served as chief operating officer of UBS Wealth Planning. David first joined UBS as a senior member of UBS Private Wealth Management, and was involved in the creation of that business for the firm. During his tenure with UBS, he also served as the chairman and president of UBS Life Insurance Company USA, Inc.; the chairman and president of UBS Financial Services Insurance Agency, Inc.; and a board member of UBS Trust Company, N.A.
Prior to joining UBS, David was a director in Merrill Lynch's Private Banking & Investment Group. He joined the firm's International Private Banking business in London and was a key member of the firm's Corporate Strategy unit.