Final expense insurance policies are in actuality small life insurance policies that are meant to pay for funeral expenses and other remaining debts of the deceased.
These policies are purchased through life insurance companies and have a low face value, typically between $5,000 and $50,000.
Policy holders name a beneficiary during the purchasing process. At the time of passing, the beneficiary makes a claim and is able to pay for funeral expenses as well as any other remaining expenses.
There are two types of final expense insurance policies, term life and whole life.
Term life policies are designed to pay death benefits only if the policy holder dies before a certain amount of years or age specified in the policy, whichever comes later. If the policy holder lives past the specified number of years or age, the policy is cancelled and no death benefits are paid. The time period is usually twenty years and the age threshold is usually eighty years. Most providers of term life insurance will exam your medical history and some will require an exam. People in poor health may be subject to a graded death benefit, which limits or completely denies death benefits if a death occurs during the first few years (usually 2-3 years) of the policy. Premiums may also increase over time during the life of the policy.
Whole life policies have a death benefit component and a savings account component, which are given to beneficiaries upon the death of the policy holder. So part of the premium goes towards paying to keep the death benefits active and part of the premium goes into a savings account. Money in the savings account is usually invested in stocks, bonds, money markets, or other investment vehicles. The actual investment portfolio ratios will depend on a number of things, such as the time horizon, the risk profile of the policy holder, and the account manager’s discretion. Funds in the savings account hopefully gain a good return on investment by the time a claim is made by the beneficiary. Combined with death benefits, these funds can be substantial and can go beyond paying for funeral expenses. In some cases they can set beneficiaries up for life.
So which type of final expense policy is best for you? It really depends on your unique situation. Both term and whole policies have their advantages and disadvantages.
Term policies have much lower premiums than whole policies, so they are a good choice if you want to minimize your monthly expenses. However, if you survive past the agreed upon term specified in your policy, your policy will become null and you lose out on all the premiums which you have already paid.
If you feel uncomfortable with the possibility of losing your death benefits as well as not getting anything in return for your premiums, whole policies might be the better option. Death benefits on whole policies never expire as long as you pay your premiums. Plus, you get the peace of mind knowing that a portion of your premiums are put into savings and not completely going to waste. However, the Premiums for whole policies are much higher than premiums for term policies. That’s because you are essentially forcing yourself to save money in addition to paying premiums. Also consider the fact that insurance agents get big sales commissions for selling these policies, in actuality a portion of every premium that you pay goes to the selling agent. Furthermore, not all, but many of these policies have a poor choice of investments, laden with bad performing vehicles and high commissions. Lastly, if you choose to cancel your policy you must pay a hefty fee.
Most experts agree that term policies are the better choice for most people since they can simply start their own separate investment account such as an IRA or 401K, essentially doing the same thing that whole policies do, but without the high commissions, and with better performing investments as well as the freedom to invest whenever they want. Beneficiaries can also be designated on these types of accounts. However, whole policies can make sense for wealthy persons who are already maxing out contributions to all possible retirement and health savings accounts.
Keep in mind that no matter what type of policy you get, beneficiaries are not legally bound to carry out the wishes of the deceased and use the funds in the manner which the deceased requested. So if you are purchasing final expense insurance, please choose a beneficiary that you trust will manage the funds well and execute your funeral arrangements as requested. If you feel nobody whom you know can carry them out, consider pre-need insurance.