Key Life Insurance Concepts

What is life insurance, what are the types, why you may need it and how to get it.

Benjamin Franklin said, “in this world, nothing is certain except death and taxes.” Although we will die and pay taxes, life insurance is a great way to ensure that those you love are cared for financially, and fortunately, it often pays out tax free!

Why do I need life insurance?

When you die, so does your income, which can make paying bills, supporting loved ones, covering debts, and achieving future financial goals difficult. Having life insurance can provide peace of mind that the life you are living and hope your family to have stays on track, whether you are there or not.

Life insurance is simply designed to give your family money if you die that they would have had if you were still alive and working for it over time. It can also be smart to have it with business partners or other family members who may rely on you financially.

Tips to Know:

• People who should have a life insurance policy:
• Parents with minor children or cosigned a loan for adult children
• Seniors who want to leave money to adult children who provide their care
• Children or young adults who want to lock in low rates
• Stay-at-home spouses because according to Salary.com, their economic value is equivalent to an annual salary of $162,581 in 2018!
• Wealthy families who expect to owe estate taxes
• Businesses with key employees
• Married pensioners who want to utilize a pension maximization strategy
• Those with preexisting conditions

What is Life insurance?

Life insurance is a contract between you and an insurance company. You pay a premium each month and if you die before the contract expires, they write your family a check for the death benefit.

Tips to Know:

• Key insurance terms:
• Premium: what you pay each month or year to have the coverage
• Death Benefit: the amount of money paid to your beneficiary when you die
• Policyowner: the person who owns the policy
• Insured: the person whose death will cause the death benefit to pay out.
• Beneficiary: the person who receives the death benefit when the policyowner dies
• Premiums are determined by several other factors: age, gender, smoking, health, lifestyle, medical history, and believe it or not, driving records. Costs of premium can even vary between insurance carriers for the exact same person and coverage amount.
• The policyowner and insured are often the same person. The most common examples where this isn’t the case are parents taking out life insurance policies on their children, businesses/business partners taking out key person policies, and viatical settlements.
• To purchase a life insurance policy, you must have an insurable interest in the person (you must experience financial loss or other hardships if that person dies).
• Many insurance companies also offer riders, which are ways to add features like return of premium or coverage for your children or long term care protection to your policy.

How Much Life Insurance Should I Have?

Everyone’s financial situation is different but, here are two ways to determine how much coverage you need:

• First simple way, have at least 15x your annual income in coverage
  • Example: salary of $100,000 a year x 15 years = $1.5M of coverage
• Second more precise way, add up your liabilities (debts, estimated funeral cost, goals for your family like college) and estimate how much you want to provide for how many years for your family
  • Example: debt of $500,000 + $15,000 funeral + 2 kid’s college $200,000 ($100,000 each) + 10 years of $100,000 income = $1,715,000 of coverage

Types of Life Insurance

There are a lot of types of life insurance contracts and there are pros and cons of each contract. Once you know how much life insurance you need, it’s helpful to decide why you want it and for how long. Once you know those three things, it makes it easy to decide which type of policy to choose.

Temporary Life Insurance

For most people, term life insurance can be a great fit. It provides temporary coverage for a low cost. For people primarily looking for protection until their children move out or their mortgage is paid off, term life insurance is usually the best option.

Tips to Know:

• Term life insurance only pays out if you die before it expires. If you live past the expiration date, there is no more protection, and you don’t get money back. There are two main types of term insurance, ones with level premiums and ones with increasing premiums.
• Level-Premium: for these policies, the death benefit, length of coverage and cost are all fixed. You could have a 30-year policy of $1,000,000 that costs $75 a month. You’d have the $1,000,000 of coverage and a monthly payment of $75 till the end of 30 years.
• Increasing premium: for increasing term policies (also known as yearly renewable term) policies the benefit stays the same but the cost goes up each year as you get older. You don’t have to reapply each year, but these can get expensive as you get past 50 so people often cancel these before the policy actually expires.

Permanent Life Insurance

Permanent life insurance as actually the first recorded type of life insurance in history. There are three primary types of permanent life insurance but the right one for you depends on why you want life insurance.

The two key benefits of permanent life insurance are your coverage lasts till death and you can often access the money you put into it tax efficiently. With these benefits over term insurance, it is certainly more expensive but can sometimes be a fit for those who want to leave an inheritance or pay estate taxes or save money safely.

Whole Life Insurance

Whole life insurance is permanent life insurance that lasts your “whole” life if you pay your premiums. Whole life insurance has both a permanent death benefit and something called cash value. Cash value is a portion of your premiums paid that receives a dividend and you can access before you die if desired. Because of the cash value function and coverage till death, whole life insurance is more expensive than term life insurance.

Tips to Know:

• Like a level term policy, your premiums for a whole life insurance policy are fixed for life
• You can borrow against the policy for future financial needs. This allows you to take a loan against your policy up to the amount of your cash value tax free. Any outstanding loans at the time of your death will be deducted from your death benefit.
• If you have an emergency and can no longer afford your premiums, most whole life policies allow you to surrender your policy to gain your cash value. Note: If you surrender your policy within the first few years of owning it, you may have to pay surrender fees.

Universal life insurance

Universal life insurance is sometimes called adjustable life insurance because of its flexibility. You can often reduce or increase your death benefit and pay your premiums at any time in any amount (subject to certain limits) once there is money in the account.

Tips to Know:

• Unlike whole life, because you have flexibility in payments your death benefits and premiums may not be guaranteed with a universal life policy
• With the flexibility of premiums you can pay a lot at once and sometimes go a long time without paying again so with people with fluctuating incomes, this can be a nice feature

Variable life insurance

Variable life insurance combines death protection with a cash value account that can be invested in the market. The value of the policy may grow more quickly but it also involves more risk. If the underlying investments do not perform well, the cash value and death benefit may decrease. Some policies, however, guarantee that the death benefit will not fall below a minimum level.

Tips to Know:

• Like universal life, with variable life you can adjust premium payments based on your needs and investment goals.
• Although variable life insurance offers this flexibility, it is essential to understand that if you don’t pay premiums for an extended period, you could lose your coverage
• Variable life insurance is usually invested in sub accounts that are created by the insurance company and can mirror mutual funds or index funds

How to Get Life Insurance

You can get life insurance through your employer, with an online broker or through a trusted advisor or agent. No matter how you get your life insurance, you will pay a commission which is part of your premium. With the application, the insurance company will also review past medical records and can sometimes order a nurse visit to check your vitals.

Be sure to work with someone you trust who helps you choose the right insurance company to obtain coverage with. The credit quality (balance sheet strength) of life insurance carrier will impact what your premiums are, how likely the company is still to be in business decades from now and the experience your family will have working with them when you pass.

Key Takeaways

When it comes to choosing life insurance, remember to determine why you need it, how much you need and for how long. Each type of policy exists for a different need so be sure which policy you choose aligns with your needs and goals. Then work with a trusted person to customize your policy to fit your needs and apply to get approved with the right insurance company.

Disclaimer: This post is for informational purposes only and is never to be taken as advice or a recommendation. Talk to a tax or legal professional to determine how this information best applies to your personal situation.