What
is Life Insurance?
Life insurance
is a contract between you and an insurance company to protect your
family in case of your death, by providing funds to pay outstanding
bills, taxes and income loss. The premium you pay to keep a contract
active is based on the type and amount of life insurance you buy and
your chance of death while the policy is in effect.
An individual’s
need for life insurance changes over their lifetime. At any age, you
should consider your personal circumstances and the standard of living
you wish to maintain for your dependents. In most cases, you need
life insurance if someone depends on you for support like in the following
situations:
• Funeral
Costs- money for funeral and burial expenses
• Debt - bills, credit card debt, and student loans
• Mortgage Protection - pay off a mortgage or monthly rent payments
• Income Replacement - provide an additional income source so
surviving family members can maintain the same standard of living.
• Education - ensure that your dependents’ education is
covered
• Taxes - estate and inheritance taxes can be pre-funded
How
Much Life Insurance Do I Need?
A person typically
purchases a life insurance policy with the intent to replace income
in the event of their death. Professionals recommend that you buy
5-10 times your current annual income. This does not include current
assets or special needs your family may have.
To determine how
much life insurance you need, you should identify the financial impact
of a premature death as a specific dollar cost. You can calculate
your needs with our life
insurance calculator.
If you are married,
you should consider the financial impact of the death of either spouse.
Plus, you should think about how long each need will last and whether
it will increase or decrease over time. Once you calculate the financial
impact of a premature death, you can compare that amount to the resources
you currently have available. If there is a difference, you can decide
which needs to address first and begin to explore alternative ways
to fund any shortfall. Focus first and spend your premium dollars
on those needs with the greatest financial impact and the most immediate
time frames.
What
Kind of Life Insurance Do I Need?
There are many
kinds of life insurance, but they generally fall into two categories:
term insurance and permanent insurance.
Term insurance
offers protection for a certain time period. It pays a benefit only
if you die during the term. Some term insurance policies can be renewed
when you reach the end of the term, which can be from one to thirty
years. The premium rate increases at each renewal date.
Advantages
- Initial premiums
are usually lower than those for permanent insurance, allowing you
to buy more coverage at a younger age when the need is often greatest
- Term insurance
works well for covering temporary needs like car loans or mortgages
- Proceeds are
not taxable to your beneficiaries
Disadvantages
- Premiums increase
as you get older
- Coverage may
terminate at the end of the term
- The policy usually
does not offer cash value
What
Term Period is Right for Me?
There are a few
main reasons for buying term life insurance depending on the length
of time that most fits your needs.
5 Year –
The more specific your need for insurance is, the shorter the term
period should be. For example, if you have a child going to college
for four years and no need for the insurance after, a 5-year term
may be right for you.
10 Year –
A 10-year term period works, for example, if you are a business owner
with a key employee that you want to cover with life insurance but
don’t expect the employee to stay in the same position.
15 Year- Many
families choose 15-year term policies to replace one or both of the
parents' income(s) in the event of death. This is especially useful
in households where the children will be self-supporting before the
15-year term has expired, or your home has a 15-year mortgage.
20 Year- A 20-year
term is a very common choice for people seeking longer-term coverage
because of the cost-effective nature of the premiums. The total premium
on a 20-year policy generally costs less than purchasing a 10-year
policy and keeping the same for an additional ten years. If you have
young children at home, a 20-year term policy could be the right choice
for seeing them through their college years.
30 Year- This
is a good choice for people with a 30-year term mortgage. The life
insurance policy can cover the entire period to alleviate the burden
of mortgage payments in the event of your death.
What Do I Do When My Term Period Ends?
The insurance
company will contact you to tell you that the policy is about to expire
and provide you with three options.
Keep your existing
policy - You can still pay on the existing policy after it expires.
It will automatically continue as an extension of your existing policy.
If your health is bad, you will not need to provide medical evidence
of your insurability. However, with this option, the policy likely
becomes annually renewable so the premiums will increase every year.
Get a new policy
- Depending on your age and health, you can apply for a new policy
with either your existing company or a new company. The new policy
replaces the former policy but be careful when doing this because
new underwriting requirements must be met. Be sure to keep your old
policy in force until you know the outcome of your new application.
If your health has deteriorated you might face higher premiums or
even be refused coverage.
Convert to a permanent
policy - You can convert your policy to a Permanent Life Insurance
policy and lock in your premiums at a higher level for the rest of
your life.
Permanent insurance
provides lifelong protection. As long as you pay the premiums, the
death benefit will be paid. These policies are designed and priced
for you to keep over a longer period of time.
Permanent policies
include: whole, universal, and variable life. Unlike term insurance
policies, most permanent policies have a cash value to provide you
with the following options:
- You can cancel
all or part of the policy and receive the cash value as a lump sum.
If you surrender the policy early on, there may be little or no cash
value.
- If you stop
paying the premiums, you can use the cash value to continue your current
insurance protection for a specified amount of time or to provide
a lesser amount of coverage over your lifetime.
- You can borrow
from the insurance company, using the cash value as collateral. Unlike
loans from most financial institutions, the loan is not dependent
on credit checks or other restrictions. You must repay any loan with
interest or your beneficiaries will get a reduced death benefit.
With all types
of permanent policies, the cash value is different from the policy’s
face amount. The face amount is the money that will be paid at death
or policy maturity. Cash value is the amount available if you surrender
a policy before its maturity or your death.
There are three
main types of permanent insurance:
- Whole life is
the most common type. Premiums generally remain constant over the
life of the policy and must be paid periodically in the amount indicated
in the policy.
- Universal life
allows you, after the initial payment, to pay premiums at any time,
in varying amounts, subject to certain minimums and maximums. You
can increase or decrease the death benefit more easily than under
a traditional whole life policy.
- Variable life
provides death benefits and cash values that vary according to the
performance of a portfolio of investments. You can allocate premiums
among a variety of investments including stocks, bonds or guaranteed
interest accounts.
Advantages
- Protection is
guaranteed for life as long as premiums are paid
- Premium costs
can be fixed or variable to meet personal financial needs
- You can accumulate
cash value, tax deferred
- The policy accumulates
cash value that can be borrowed against to pay premiums
- Cash value can
be partially or totally surrendered for cash or converted into an
annuity
Disadvantages
- Minimum premium
levels can make it difficult to buy enough protection
- Permanent insurance
may be more expensive than term insurance if it is not kept over a
long time period
