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What Is Modified Benefit Whole Life Insurance?
What is modified benefit whole life insurance? In short, it’s a type of coverage that offers lower premiums for the first 3 to 5 years before rising to a higher cost for the rest of your life.
What Are Life Insurance Premiums?
Life insurance premiums are the amount you pay per month to keep your policy in force. It’s similar to the subscription fee you pay for your favorite streaming services, but with some added complexities. Unlike a streaming service, your premiums are tailored to you. Your coverage type, policy value, age, sex, and any health conditions are all factored into your cost of insurance.
Premiums are in place for three reasons:
- For an insurer to cover their liabilities (the death benefit that goes to your loved ones). When a policyholder dies, the insurance company is responsible for paying their death benefit in a timely manner once a claim has been filed. The payments they collected from that policyholder and others are designed to pay off these claims, ensuring your beneficiaries receive the death benefit they're expecting.
- For an insurer to cover their business expenses. Premiums also go towards covering business expenses, such as employee salaries, legal fees, office space, marketing costs, and more.
- To invest and earn more money to help with both of the above costs. Insurers also invest a portion of the premiums they collect to grow the value of the company and to grow the funds that pay off death benefits. Permanent life insurance policies have a built-in cash value savings component that accumulates value over time from investing a portion of the policyholders’ premiums as well.
Life insurance premiums are, in a sense, insurance for your insurance company. If you're a higher-risk customer who is older and has health concerns, the company is more at risk of having to pay a death benefit. You may be thinking, “But isn’t it their job to pay death benefits?” You’re correct, but if an insurer pays too many death benefits on policyholders who haven't made as many premium payments as younger adults with no health conditions, they would eventually be losing too much money to pay every death benefit.
Low-risk investments, or younger and healthier policyholders, will pay less because they are less of a financial risk to insurers. Term policies are also associated with lower costs because they expire, meaning your insurance company could collect premiums for 10 to 20 years and never have to pay a death benefit.
Want to learn more about what happens to term life insurance if you don’t die? Check out our article here.
What Is Whole Life Insurance?
Whole life insurance is a type of permanent coverage that will last your entire lifetime if you make your premium payments. In addition to permanent protection, it comes with a built-in cash savings component that accumulates value over time.
A portion of your payment goes towards the cash value and is invested to gain value faster than your regular bank savings account, as it is tax-deferred. This cash fund can be accessed during your lifetime to supplement retirement, pay for education, cover emergency expenses, and more. If it goes unused, it may be added to the death benefit value your beneficiaries receive in the event of your death. Some insurers offer that benefit, while others don't.
Whole life coverage is designed to protect your loved ones and create an immediate estate to build wealth during your lifetime. If you want to learn more about how whole life insurance can be used for estate planning, you can read more here.
There are several kinds of whole life coverage:
- Traditional: your cash value fund will grow at a predetermined rate set by your insurer. Different companies will have different growth rates for you to consider when shopping. Your premiums will remain the same over the life of your contract.
- Indexed: your cash fund will grow at a fluctuating rate because it's based on an investment index set by your insurer, such as the S&P 500. There's typically a set minimum threshold to ensure you don’t lose money, and sometimes a set maximum threshold, too. There is a higher potential for growth, but an added level of risk and the cost of management fees on your gains. Your payments will stay level.
- Limited Payment: you will pay higher premiums for a set number of years until your contract is considered “paid-up.” Once you are paid-up, you will never have to make another payment to keep your coverage. The shorter the period, the higher the payments will be.
- Single Premium: as the name suggests, you will only have to make a single payment for your entire contract. Not all providers have this as an option, but if you have the funds to purchase your entire policy and don’t want to make recurring payments, this could be an option for you. Starting costs are between $5,000 and $10,000 and increase depending on your death benefit value.
- Modified Benefit: also referred to as modified or graded life insurance, it has all the same features as traditional coverage, with the exception of level premiums. The first 3 to 5 years of your contract will come with lower payments, before increasing a single time to higher premiums that will remain level for the remainder of your contract. Most modified policies do not begin to contribute to your cash value until after the introductory period of lower premiums has ended.
What Is Modified Benefit Whole Life Insurance?
There are two major differences between modified benefit and traditional whole life contracts:
- The premiums
- Cash value
The death benefit remains the same for both kinds of coverage.
Traditional, or standard, whole life coverage has level premiums over the entire length of your policy. Modified benefit starts off with lower premiums that make this type of contract appealing initially. But there's a catch. After the introductory period ends, the premiums typically rise to an amount higher than a traditional contract with the same death benefit value.
So why is this a good thing? The idea is to purchase more coverage now than you can afford initially, with the assumption that you will have a larger income in a few years to afford the higher costs.
However, if your finances change for the worse between purchasing the policy and the costs rising, you may find yourself paying for coverage you can no longer afford. In addition, traditional coverage starts building your cash value immediately, taking a portion of your payments to invest and grow. Because modified benefit policies start off with a significantly lower premium, that portion that would go to your cash fund isn't there. It may not seem significant to lose out on just 3 to 5 years of growth, but it can have a significant impact on the potential growth of your policy.
What's the take-away? While this type of coverage is cheaper initially, it typically ends up being more expensive long-term and comes will less cash value accumulation.
Other Options
If you're looking for a more affordable policy and aren't interested in accumulating a cash value fund, you may want to consider term life insurance. For the same death benefit amount, term coverage is significantly cheaper. Because a portion of your premium payment for permanent coverage goes towards your cash fund, it's always going to be more expensive than term coverage.
If you've already been pricing whole life policies, keep in mind that the introductory period of a modified benefit whole life insurance policy is similar to what it would cost for a term policy of the same face value. What makes a term policy more affordable? It's due to the lack of cash value and the possibility that you'll outlive your term and the insurer will never have to pay out on your behalf.
So what's the right decision for you and your family? We can help if you're not sure. Call us at (800)521-7873 or email us at info@lifequote.com and tell us a bit about your current financial situation and your coverage needs. Once we know a little more about your situation, we can explain your options.
Bottom Line
While a modified benefit whole life insurance policy may seem enticing due to its lower premiums for the first years of coverage, it can have a significant impact on your finances that sets you back. It may be in your best interest to go with a traditional coverage or a term policy instead. Since everyone’s situation is different, it may help to give us a call and walk through what option is best for you. Call us at (800)521-7873 or email us at info@lifequote.com and we’ll get you covered!
