Life insurance has long carried an awful stigma of being morbid. Having to think about and preparing for “death” goes against our nature and for this reason, life insurance is something we automatically dismiss when we think of financial responsibility.
The importance of life insurance doesn’t quite hit us until we get married, have families, or begin to realize that others are dependent on us for their stability, sustenance, well-being, and most basically, daily survival.
What we don’t realize is that generally, the earlier in our lives we get life insurance, the more cost effective the premium is for a larger policy, which means more security for your beneficiaries.
Life insurance isn’t for our own benefit, it’s for the benefit of those we love and those who depend on us. This is why people need life insurance. Having a plan if something should happen is not only important, but necessary in our day and age.
The type of life insurance you need depends on a lot of different factors, including age, lifestyle, and where you are in your life, but there are plenty of policies to fit any budget. In our modern economy, life insurance has become a necessity so it’s become almost senseless to dismiss it as being financially responsible.
What is Life Insurance and What Does Life Insurance Cover?
Life insurance is the cornerstone of having a well-rounded financial plan and can cover a variety of situations, plus it acts as a safety net for your spouse, partner, children or dependents. In some cases it can even act as an investment.
Here’s what life insurance covers:
Replacement income for dependents
If you have family members or friends that depend on your income and you pass away, your life insurance will replace that income. Most people think of parents and children when discussing this type of coverage, but it also applies to couples with no children, parents that still depend on you for financial stability and any other dependent. Life insurance is especially important if any government or employer sponsored benefits for your spouse or partner will be reduced or removed after you pass away.
Pay final expenses
Life insurance can help cover costly funeral and burial expenses and any other estate costs, debts or medical expenses not covered by your health insurance.
Create an inheritance for your heirs
Regardless if you have any other assets to pass along to your heirs, you can create an inheritance for them by purchasing a life insurance policy and naming them as beneficiaries.
Pay federal “death” taxes and state “death” taxes
Life insurance benefits can pay estate taxes so that your heirs will not have to “liquidate” or sell assets or take a hit to their inheritance.
Make significant charitable contributions
Add your favorite charity to your life insurance policy to make a much larger contribution than you would have been able to with cash.
Create a source of savings
Some types of life insurance coverage have the option to create cash value that can be borrowed or withdrawn on your request. Buying a cash value type of policy, you can create an instant savings plan and the interest credited is tax deferred or tax exempt if the money is paid as a death claim.
There are two main types of life insurance
There are two major types of life insurance—term and whole life or permanent insurance.
What is term life insurance?
Term insurance is the the most straight-forward form of life insurance. It pays out only if the death occurs during the term of the policy, which can be anywhere from one to 30 years. Most term life insurance policies have no other benefit provisions.
There are two basic types of term life insurance policies:
Level term: This means that the death benefit stays the same throughout the duration of your policy.
Decreasing term: This means that the death benefit drops, typically in one-year increments, over the course of the policy’s term.
What is Whole Life or Permanent Insurance?
Whole life or permanent insurance pays a death benefit whenever you die—even if you live to 105! There is no cut off date on whole life/permanent insurance.
There are three major types, each with their own variation of benefits: traditional whole life, universal life, and variable universal life.
Traditional whole life: In traditional whole life insurance, both the death benefit and the premium stay the same throughout the life of the policy. The cost per $1,000 of benefit increases as the insured person ages, but the insurance company does not increase the premium every year. Instead they keep the premium level by charging a premium that is higher than what realistically is needed to pay claims. This helps keep the premium the same and keeps life insurance affordable for people as they age. In many whole life policies your death benefit as well as cash value may (but are not guaranteed to) grow substantially throughout the life of the policy.
Universal Life Insurance: Universal life insurance is a hybrid between whole and term life insurance. Typically a UL can accumulate cash and money is subtracted monthly from the cash portion of the policy to pay for the cost of the insurance (which increases annually). Any premium payments that exceed the cost of insurance are placed into the cash portion of the policy and earns interest. Premiums are normally found to be more expensive than term, but less expensive than a traditional whole life plan. Premiums can be adjusted up or down throughout one’s lifetime.
How to choose the right type of life insurance?
Choosing the right type of life insurance can be confusing since there are so many options out there, but it’s an important decision. Here are some simple guidelines that will help you decide which life insurance is best for you:
Consider purchasing term life insurance if:
You need life insurance for a specific period of time. For example, if you have children/teens and want to make sure there will be enough money to pay for their college education, you may buy 15 or 20 year term life insurance.
You need a large amount of life insurance, but are limited by what you can afford. Term life insurance pays only if you die during the term of the policy, so the rate is lower than for permanent life insurance. If you think your financial needs may change, look into “convertible” term policies. These policies allow you to convert to permanent insurance without a medical examination in exchange for higher premiums.
Keep in mind that premiums are lowest when you are young and increase upon renewal with age. Some term insurance policies can be renewed when the policy ends and some policies require a medical examination at renewal to qualify for the lowest rates.
Consider permanent or whole life insurance if:
You need life insurance for as long as you live. A permanent policy pays a death benefit whether you die tomorrow or live to be over 90.
You want to accumulate a savings element that could be a source of funds if needed. The savings element can be used to pay premiums to keep the life insurance policy ongoing if you can’t pay them otherwise, or it can be used for any other purpose you choose, regardless of your credit.The death benefit is collateral for the loan and if you happen to pass away, the insurance company collects what is due before giving what is left to your beneficiary.
Premiums for permanent policies are generally higher than for term insurance. However, the premium in a permanent policy remains the same no matter how old you are, while term can go up substantially every time you renew it.
There are a number of different types of permanent insurance policies, such as whole (ordinary) life, universal life, variable life, and variable/universal life. For more details, see our description below on the specific types of policies.
Life Insurance as an Investment Vehicle
In addition to having financial protection, whole or permanent life insurance offers some cash growth benefits that are worth considering.
Here are some whole life policies that also offer investment features:
Traditional Whole Life Insurance: Whole life insurance policies cash growth can become a supplement in someone’s retirement plan. When someone has a life insurance need, but would also like cash growth to fund some of their retirement a whole life plan could be the best route. The cash value can be borrowed from the policy tax free and the remainder inside of the policy at the insured’s death would pass on to the heirs tax free.
Universal Life Insurance: Universal life insurance is similar to term life insurance except it can accumulate cash. Money is subtracted monthly from the cash portion of the policy to pay for the cost of the insurance (which increases annually). Any premium payments that exceed the cost of insurance are placed into the cash portion of the policy and earns interest. Other features of a universal life insurance policy include:
A minimum interest rate is guaranteed on the policy’s accumulated value each year. A higher interest rate is paid when interest rates are high.
Flexibility regarding premium payments. You can choose to pay additional premium, pay a reduced premium or completely skip a premium payment if there’s sufficient cash in your policy to cover the insurance and administration costs.
Policy loans and cash withdrawals are available depending on the cash value.
Universal life insurance requires active monitoring and participation. You will be provided with an annual statement showing all policy activity and will be responsible for reviewing the statement and making any required changes.
Adjustable Life Insurance Policy: An adjustable life insurance policy allows you to increase or decrease your coverage by changing the amount of premium payments or the period of coverage.
Indeterminate Premium Life: Indeterminate Premium Life policy is also known as a non-guaranteed premium life insurance policy or a variable-premium life insurance policy. After an initial guaranteed period, insurers can adjust premiums, but the premiums cannot exceed a maximum rate. This feature allows you to initially purchase a policy at a lower price.
Interest-Sensitive Whole Life Insurance: Interest-Sensitive Whole Life Insurance is also known as current assumption whole life insurance. Premium rates vary in this policy are just like in an indeterminate premium life insurance, but the cash value can grow to be greater than that guaranteed. The additional cash value can be used to lower your premium or increase the cash value of your policy. Once again, there is a maximum guaranteed premium rate which the insurer cannot exceed.
Why do you need life insurance?
As you have read above, life insurance does more than just provide financial protection and is needed for people of all ages. The younger you are when you begin to invest in a plan, the higher your benefits and cheaper the premiums will be. Having a plan if something should happen is important. No matter what your age, you need life insurance. If you have no life insurance your family and dependents will be left with nothing to help fill the financial gap from your passing.
With so many life insurance policies to chose from, it’s important to decide what factors are important to you (providing for a family, future cash value, paying off debt) and then meet with a life insurance agent to discuss which policy that meets your needs and budget.