Many people do fully understand what life insurance is and how it works. This is partly because life insurance is somewhat complex, and partly because it is a very flexible type of insurance that offers many opportunities for creating security for you and for your family.
The two basic types of life insurance are:
Term life insurance: A term life policy is in force for a specific time and has a face value (coverage amount) that you specify when you buy the policy. In the event that you die within the specified term, the insurance company pays the face value of the policy as a death benefit to your beneficiaries.
Permanent life insurance: A permanent life insurance policy (which includes whole life, universal life and variable life insurance) is in force for your lifetime as long as you continue to make your premium payments. Like term life insurance, permanent life insurance pays a death benefit. But it also has an accumulating cash value.
What Does Life Insurance Cover?
In its basic form, a life insurance policy provides death benefits and is designed to cover loss of income, end-of-life expenses, funeral costs and other financial needs that a family may have if you – the policyholder – should die unexpectedly.
While death benefits are often designated for funeral expenses and income replacement, life insurance is a very flexible type of coverage that can be used in numerous ways.
Cost of living: Life insurance can cover your family’s vital expenses after your passing, such as the payment of your mortgage, outstanding debts and children’s college tuition.
Trusts and charities: You can use life insurance policy to create a trust as a financial legacy for your heirs, a chosen charity or other organization.
Retirement and estate planning: A permanent life insurance policy can be structured to cover your living costs during your retirement or for estate planning, and can even cover the cost of your life insurance premiums.
Business continuation: Business owners often purchase life insurance that can help protect their business in the event they die unexpectedly. For example, a business owner can construct a buy-sell agreement that pays benefits to one or more surviving co-owners who can then purchase the policyholder’s share of the enterprise.
How Much Life Insurance Do I Need?
Life insurance can be tailored to your specific needs, taking into account your family’s financial picture and your future financial security. The amount of life insurance you need depends on your goals, your family, and the expenses you want your family to be able to cover once you are no longer there to support them.
Here are three separate scenarios to consider:
If you simply want to cover your end-of-life expenses and funeral costs so that your family is not burdened by these expenditures, you might want to buy a small term life policy, such as $10,000 to $20,000 worth of coverage.
You would want to choose a larger life insurance policy if you have dependents and you are the primary income earner for your household. People with dependents often buy term policies in amounts ranging from $500,000 to $2 million or more to ensure that their dependents’ needs will be met. Add your family’s cost of living, your personal and household debt and the projected costs of your children’s education as a starting point to determine the amount of coverage you need.
If you want your life insurance policy to accrue value and work for you or for your family as an investment vehicle, you might want to buy one of several different types of permanent life insurance. In this case, you have several different options. For example, you could purchase a $1 million term life insurance policy and begin converting over portions of the policy to a whole life insurance policy each year to build a growing cash account that will serve your needs in retirement.
How Does Life Insurance Work?
A life insurance policy is a contractual arrangement between you, the policyholder, and the life insurance company. The policyholder determines the amount of life insurance coverage required and pays the life insurance company a premium to keep the policy in force.
The way the premium will be paid will also be spelled out in the policy. The premium could be paid to the life insurance company as a lump sum, an annual or semi-annual payment, or a monthly amount, for example. The premium must be paid according to the terms of the policy to keep the life insurance policy active.
Should the policyholder die while a life insurance policy is in force, then the life insurance company will pay out the death benefits specified in the policy. Additionally (applicable to permanent life insurance policies only), the insurance company will accumulate a cash value.
Death proceeds are paid as a lump sum to the named beneficiary (the person who will receive the life insurance benefits), as stipulated in the policy.
How Much Is Life Insurance?
The cost of life insurance varies considerably based on a number of factors and can cost anywhere from $15 a month for a young non-smoking female to well over $1,000 a month for a middle-aged male smoker.
Life insurance companies use a rating system based on a number of risk factors such as a person’s age, use of tobacco, overall health status, occupation and a variety of other considerations.
A person who is relatively young does not smoke and is healthy will likely get a much better rating than someone who has an underlying health condition or risky health habits. Health conditions, high-risk jobs and tobacco use can all make a policyholder risk for an insurance company to cover. A healthy person with a good rating is less of a risk to insure, so that person’s premiums will be lower than for a person who is considered a higher risk.
Here is an overview of some of the many factors that affect your life insurance costs:
The type of life insurance you want to buy: Term insurance costs less than permanent life insurance because it only pays a death benefit and does not build up cash value.
How much life insurance you want to buy: A $20,000 term policy will cost far less than a $1 million term insurance policy.
The age at which you buy your life insurance policy: The cost of life insurance climbs dramatically as you age.
Your health profile: If you have no health conditions, your costs will be lower than if you have heart disease, diabetes or other chronic conditions.
Whether you buy medically underwritten life insurance: While it is possible to buy “no exam life insurance,” your costs will be much higher because the life insurance company is taking a higher risk to insure you than if you took a medical exam.
Note that every life insurance company uses its own algorithms to determine individual ratings and premiums. No two life insurance companies will quote the same costs for the same person, and the cost of life insurance can vary widely. For this reason, it is important to compare multiple quotes before choosing to buy a policy.
Is Life Insurance Taxable?
Life insurance proceeds are usually not taxable if they are paid to a specifically named beneficiary, such as your spouse or children. The life insurance proceeds may become taxable, however, if you name your estate as the beneficiary. At that point, the proceeds become a part of your estate and can be subject to estate taxes.
Why Is Life Insurance Important?
Life insurance can protect your family from becoming financially burdened in the event that you unexpectedly die, especially if you are the primary income earner for your household. Life insurance proceeds can help your loved ones cushion the economic impact that may occur as a result of your death.
Life insurance is important for different individuals for different reasons. For some people, it is important to cover end-of-life costs while others want to create a large financial legacy for their dependents and heirs. Some people want a life insurance policy that will help their business continue to flourish after their passing. Others want to create an endowment that will benefit an important cause or institution.
Life insurance policies have helped many families at a time of need when a primary income earner dies. When that happens, the family can be left with additional expenses and fewer financial resources. Living expenses, funeral expenses, debts, mortgage or rent payments and education costs can all create an enormous financial burden for a family when a primary income earner passes away.
Unfortunately, a large percentage of families today lack any form of life insurance, leaving open the possibility of financial hardship. Term life insurance is a highly affordable policy that can help prevent this scenario. An independent agent in the Trusted Choice network can help you get quotes and determine if life insurance makes sense for you.
When Should I Get Life Insurance?
Buy life insurance as soon as you determine that it makes sense for you or for your family. Waiting to buy life insurance is costly, as it becomes more expensive as you age. It is also easier to qualify for life insurance when you are young and have no health complications.
Many people buy life insurance as their circumstances change. When you get married, for example, you may consider purchasing life insurance in order to provide death benefits to your spouse in the event of your untimely passing. It is a good idea to evaluate your life insurance anytime you have experienced a change in your overall financial obligations.
For example, you may want to buy life insurance or increase your coverage under these circumstances:
When you get married
When you start a family
When you buy a house
When you start up a business
If you accumulate personal debt
Life insurance can help to prevent the loss of your income and your debt accumulation from being passed on to your family as a financial burden after your passing
Your life insurance policy coverage should reflect these and other foreseeable financial obligations.
How to Buy Life Insurance
When you buy life insurance, decide what you want your life insurance to pay for and what expenses your survivors will need to cover without your help.
Next, you should research life insurance and choose the type of policy that makes the most sense for you. Life insurance companies vary considerably, as do the policies they offer, the rating systems used, and the premiums they charge.