What is Straight Life Policy And How It Work?
A straight life policy, sometimes called a straight life annuity, is a retirement income product that pays a benefit until death but forgoes any further beneficiary payments or a death benefit.
What makes a straight life unique is that, once the annuitant dies, all payments stop and no more money or death benefits are due to the annuitant, their spouse, or heirs. This has the effect of making the straight life annuity less expensive than many other types of annuities and retirement income products.
A straight life insurance policy is one of the earliest types of insurance. It’s been used for centuries to grow and protect policyholders’ money and not just by the wealthy. Straight life policies have many benefits not found in other types of life insurance, like universal life, variable life, term policies, or indexed policies. But is straight life insurance right for you?
How Does Straight life Insurance Work?
Straight life insurance is a type of permanent life insurance that provides a guaranteed death benefit and has fixed premiums. Also known as whole or ordinary life insurance, the policy has a term length that lasts your entire life. This is different from term life insurance which expires after a set number of years.
What type of Premium does a Straight Life Policy have?
Straight refers to the premium structure of the whole life insurance policy. This terminology denotes that premiums for the plan will be level, meaning they will not increase or decrease during the life of the policy. For example, you could have a $100,000 straight life insurance policy for which you pay $30 a month. In this case, that $30 premium would not change for your whole life.
Other whole life insurance policies, like adjustable life insurance, can have a premium structure that may increase or decrease throughout the life of the plan. These are some of the many policy features that you can choose when deciding what the best life insurance policy is for you. For example, an adjustable plan would make sense if you know you may have changing coverage needs in the future.
1: Cash value account: As a form of permanent life insurance, straight life insurance comes with a cash value account that will grow over the life of the plan. The cash value component of a life insurance policy is separate from the death benefit. Each month, part of the premium that you pay for a straight life policy will be added to the cash value account. The rest of the premium goes towards the company’s costs for providing insurance.
The cash value is basically an investment account inside of your straight life insurance policy. This account will grow according to a guaranteed rate over the course of the policy length. The rate of return will typically be large enough that when you turn 100 the cash value account will equal the value of the death benefit. At any point, you can use the cash value account for a variety of reasons, including:
- Surrender Value – If you decide that you no longer want your policy, you can return it to the insurer and in return you will receive the cash value back.
- Loan Collateral – You can ask for a policy loan from your insurance company and use your cash value account as the collateral. The maximum you could borrow would be equal to the total value of the cash value in your life insurance policy.
Simply put, the cash value represents the amount of money invested in your life insurance policy. This balance can be used in a variety of ways, but if you remove money from the policy it will subsequently be deducted from your death benefit.
Pros and cons of straight life insurance
A straight life policy can be a valuable life planning tool if you need long-term financial planning. Since the policy is designed to last your entire life, you will be able to maximize the cash value by holding onto the plan for a longer period. Straight life will not work well for short-term needs since it will often take decades before you will see reasonable investment returns from the cash value account.
Finally, straight life insurance is significantly more expensive than premiums for a term life insurance plan. For example, the average cost of a 20-year $100,000 term life insurance policy is $199 per year. When comparing this to whole life insurance, which can have premiums over $1,000 per year for a policy with $100,000 in coverage, it shows significant cost considerations between both policies. Therefore, if you need life insurance for periods shorter than 20 to 30 years we would recommend a term policy.
Along with term life insurance, a guaranteed universal life policy is another cheap life insurance option to consider as well as being very easy to apply and be approved for. This policy is a form of permanent life insurance coverage which has a cash value account which is guaranteed to no go below zero. Thus, it can be a good solution if you want lifelong coverage without the need for the cash value account or are not certain about whether you need permanent or term life insurance. Additionally, guaranteed universal life can be considerably cheaper when compared to other permanent policies.
What Are the Benefits of Straight Life Policy
In addition to a death benefit for your beneficiary and cash value for you, straight life insurance offers a variety of benefits not found in other policies.
1: Dividends and Interest
While a life insurance policy itself isn’t considered an investment (it’s a financial asset), the cash value of a straight life policy grows like an investment. It also provides the policyholder leverage to take advantage of outside investment opportunities with policy loans. Unlike most market-based investments, however, money inside a straight life policy grows securely and reliably.
Mutual insurance companies are regulated at both state and federal levels. They must have enough liquid assets in reserve to pay 100% of their claims. Because of this requirement, insurance companies base their business models off of inevitability instead of probability. Mutual insurance companies use precise actuarial science, not market predictions or assumptions, to remain profitable for their policyholders. Their calculations are so precise, you earn a guaranteed rate of interest on your policy. This guaranteed rate makes it easier to plan financially for your future, compared to other qualified plans like 401(k) or IRA accounts. For this reason, straight life policies are popular vehicles for retirement income.
In addition to paying out claims and guaranteed interest, mutual insurance companies profit-share with their policyholders. Much like you own a piece of a credit union vs. a bank, straight life policy holders own a piece of the mutual insurance company who writes their policy. Mutual insurance companies recognize this ownership by paying out dividends on top of your guaranteed interest. Although dividends are not guaranteed, most mutual insurance companies have been paying out dividends for nearly 200 years, even during recessions.
2: The Policy Loan
You can borrow from the cash value of your straight life policy in the form of a policy loan. You don’t need credit or bank approval for a policy loan; your collateral is your insurance policy. The insurance company will charge you interest on the amount you borrow (typically less than a bank or other creditor). Any unpaid loans will be deducted, plus interest, from your death benefit.
The policy loan feature of your straight life insurance policy makes it an “AND” asset.
When you borrow from your insurance policy, you continue to earn guaranteed interest on the full cash value of your policy. In this way, each dollar works twice as hard to grow your wealth. Consider how this compares to other forms of borrowing and saving.
Saving in a bank account
When you save money in a bank savings or money market account, you earn interest over time on the funds in your account. When you withdraw those funds, your account balance drops back down to zero. Any future money you deposit has to start at square one earning interest.
Borrowing with credit
When you make purchases on credit, you owe a debt to your creditor. You pay back your debt, plus interest, over time until you have a zero net balance. The cycle repeats itself the next time you make a purchase.
Saving and borrowing with policy loans
When you save money in a straight life policy, you earn interest and potential dividends over time on the funds in your policy. When you borrow from your cash value, you pay back your debt, plus interest, over time—but you continue to earn interest on the full cash value of your account. You save AND borrow without negatively affecting interest earned.
The policy loan may be the single greatest benefit of a straight life policy. You’re essentially borrowing your own money and earning interest on yourself. Plus, you dictate the payback terms of your loan. There are no limits to what you can use a policy loan for. The leverage this offers is what sets the wealthy apart from the typical investor.
3: Tax Advantages
Straight life policies are funded with after-tax dollars. Once inside a policy, your dollars grow tax deferred. When you withdraw from your policy for retirement funds, you may be taxed on your earnings over what you’ve paid in policy premiums. In other words, the interest and dividends earned may be taxable.
You won’t be taxed on cash value borrowed in a policy loan, and the interest and dividends you earn grow tax-free. When distributed to your beneficiary, your death benefit typically is not charged estate tax/inheritance tax or income tax. This means your beneficiary will not have tax liabilities.
4: Asset Protections
Straight life insurance is designed to protect your assets. It guards against major financial risks and liabilities in four major areas:
Cash value, death benefits, and policy loans are private transactions between you and your mutual insurance company. This structure shields assets in your straight life policy from many of the common risks bank and investment accounts are exposed to.
Life insurance assets can rarely be accessed by creditors. Rather than being seized as a collection measure on defaulted loans, the cash value in your straight life policy can be leveraged to repay any creditors you owe.
In most states, the cash value in your policy is protected from garnishments and seizure that might otherwise be incurred from legal judgements. Your assets remain available to you and are passed to your beneficiary when you die.
Insurance assets are protected against lawsuits and bankruptcy in many states. They are separate from corporate and business assets, and generally protected as a personal asset. In most cases, money in your straight life policy can’t be touched by outside parties, even in the event of a damaging lawsuit.
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How to Purchase a Straight Life Annuity
There are basically two ways to purchase a straight life annuity policy:
- Making periodic payments into the annuity over the course of the annuitant’s working life
- Purchasing the annuity with a single lump-sum payment, which usually is made at, or shortly after, the annuitant’s retirement
Either payment option will result in the same regular payments and can be modified with optional riders, such as a cash-refund rider that pays out the remaining funds in the policy to a beneficiary.
Why You May Want a Straight Life Annuity
There are a number of scenarios where a straight life annuity can be beneficial to your financial strategy in retirement:
Straight life annuities provide regular funds in your later years when you may not be earning income. This helps maintain a quality of life guarantee and predictability that variable investment options may not be able to.
Like all annuities, straight life annuities act as longevity insurance, where you can be guaranteed income even if you outlive how much you initially paid into the annuity.
Considering that straight life annuities are geared towards single individuals, they are not the best choice for couples who are planning to live off of the retirement income the annuity provides.
If you’re a single male retiree, you can get the largest monthly payouts, as insurers consider men to have shortened life expectancies.
The premiums for straight life annuities can be funded in multiple ways, including:
Selling mutual funds or stocks
Transferring funds from an IRA or 401(k)
Cashing in the surrender value of a life insurance policy through a 1035 Exchange, with reduced tax liability.
For those who are recipients of large settlements or windfalls (i.e., lottery winners), straight life annuities can ensure a steady income for life while also avoiding the risk of squandering a substantial amount of funds. This also helps reduce the ultimate tax bill by accepting payment in the form of a life annuity rather than as a lump-sum payment.