Insurance Library |
Get a Life Quote
Table of Contents
Buying Life Insurance: What Kind and How Much?
- Think about which members of your household should be covered by life
insurance. (It's typically a good idea to insure anyone who earns income.)
- Find out whether you're eligible for group life insurance coverage at
work. If you already have it, review the policy to understand exactly what benefits
it provides.
- Keep in mind that you may not need life insurance if you have no dependents
and nobody else relies on you for financial support.
- Elect from multiple life insurance options that are specific to your needs
and budget.
- You will have the advantage of selecting from not one but multiple carrier
quotes to assure that you have a competitive product and price.
Buying Life Insurance
Conventional wisdom says that life insurance is sold, not purchased. In other words,
some people are reluctant to discuss the importance of owning life insurance, and
others are simply unaware of the need to have life insurance. Although many large
companies provide life insurance as part of their benefits package, this coverage
may be insufficient.
Who needs life insurance? If there are individuals who depend on you for financial
support, or if you work at home providing your family with such services as child
care, cooking, and cleaning, you need life insurance. Older couples also may need
life insurance to protect a surviving spouse against the possibility of the couple's
retirement savings being depleted by unexpected medical expenses. And individuals
with substantial assets may need life insurance to help reduce the effects of estate
taxes or to transfer wealth to future generations.
Types of Insurance
Term insurance is the most basic, and generally least expensive,
form of life insurance for people under age 50. A term policy is written for a specific
period of time, typically 1 to 10 years, and may be renewable at the end of each
term. Also, the premiums increase at the end of each term and can become prohibitively
expensive for older individuals. A level term policy locks in the annual premium
for periods of up to 30 years.
Declining Balance Term insurance, a variation on this theme, is
often used as mortgage insurance since it can be written to match the amortization
of your mortgage principal. While the premium stays constant over the term, the
face value steadily declines. Once the mortgage is paid off, the insurance is no
longer needed and the policy expires. Unlike many other policies, term insurance
has no cash value. In this sense, it is "pure" insurance without any investment
options. Benefits are paid only if you die during the policy's term. After the term
ends, your coverage expires unless you choose to renew the policy. When buying term
insurance, you might look for a policy that is renewable up to age 70 and convertible
to permanent insurance without a medical exam.
Whole Life combines permanent protection with a savings component.
As long as you continue to pay the premiums, you are able to lock in coverage at
a level premium rate. Part of that premium accrues as cash value. As the policy
gains value, you may be able to borrow up to 90% of your policy's cash value tax-free.
Universal Life is similar to whole life with the added benefit
of potentially higher earnings on the savings component. Universal life policies
are also highly flexible in regard to premiums and face value. Premiums can be increased,
decreased or deferred, and cash values can be withdrawn. You may also have the option
to change face values. Universal life policies typically offer a guaranteed return
on cash value, usually at least 4%. You'll receive an annual statement that details
cash value, total protection, earnings, and fees. Drawbacks to this type of insurance
include higher fees and interest rate sensitivity. Universal policies include up-front
fees as well as ongoing administrative fees totaling as high as 5% to 7% of your
premiums. You may also find your premiums increasing when interest rates decline.
Variable Life generally offers fixed premiums and control over
your policy's cash value. Your cash value is invested in your choice of stock, bond,
or money market funding options. Cash values and death benefits can rise and fall
based on the performance of your investment choices. Although death benefits usually
have a floor, there is no guarantee on cash values. Fees for these policies may
be higher than for universal life, and investment options can be volatile. On the
plus side, capital gains and other investment earnings accrue tax deferred as long
as the funds remain invested in the insurance contract.
Universal Variable Life insurance is the most aggressive type of
policy. Like variable life, you control your investment in mutual funds. However,
there are no guarantees on universal variable policies beyond the original face
value death benefit. These policies are probably best suited to affluent buyers
who can afford the risks involved.
Key Terms and Definitions
- Face Value -- The original death benefit amount.
- Convertibility -- Option to convert from one type of policy (term) to another (whole
life), usually without a physical examination.
- Cash Value -- The savings portion of a policy that can be borrowed against or cashed
in.
- Premiums -- Monthly, quarterly, or yearly payments required to maintain coverage.
- Beneficiary -- The individual(s) or entity (e.g., trust) that is designated as benefit
recipient.
- Paid Up -- A policy requiring no further premium payments due to prepayment or earnings.
How Much Insurance Do I Need?
A popular approach to buying insurance is based on income replacement. In this approach,
a formula of between five and ten times your annual salary is often used to calculate
how much coverage you need. Another approach is to purchase insurance based on your
individual needs and preferences. The first step is to determine your unique income
replacement needs.
Currently, a large portion of your income goes to taxes (insurance benefits are
generally income tax free) and to support your own lifestyle. Start off by determining
your net earnings after taxes. Then add up all your personal expenses such as food,
clothing, magazine subscriptions, club memberships, transportation expenses, etc.
The remainder represents annual income that your insurance will need to replace.
You'll want a death benefit amount which, when invested, will provide income annually
to cover this amount. Then, you should add to that the amounts needed to fund one-time
expenses such as college tuition for your children or paying down mortgage or debt.
Income replacement for nonworking spouses is an important and often overlooked insurance
need. Coverage should provide for your costs for day care, housekeeping, or nursing
care. Add to this any net earnings from part-time employment.
Finally, estimate your own "final expenses" such as estate taxes, uninsured medical
costs, and funeral costs.
Medical underwriting will be required for these life insurance products.
Other Types of Life Insurance
Survivorship life insurance (also referred to as last-to-die or
second-to-die) is a unique type of contract that insures the lives of two people.
It pays a death benefit upon the death of the second insured. Therefore, it is typically
less expensive than two individual policies. Survivorship life is often used for
estate planning, where it may be possible to potentially leverage today's dollars
-- via insurance premiums -- into a potentially significant death benefit that can
be used to fund estate taxes, create wealth for future generations, or benefit a
charity. These policies may be available if one insured is medically "uninsurable."
First-to-die life insurance insures the life of at least two people
and pays a benefit upon the death of the first insured. This policy is useful for
covering a mortgage or other large debt obligation where there is more than one
debtor. In addition, it can be an ideal tool for funding a buy-sell agreement within
a closely held business.
Conclusion
Life insurance is an important component of a sound financial plan. Buying insurance
involves asking a variety of personal lifestyle and financial questions. If you
are not already working with an insurance professional, you may want to consider
the advice of a fee-for-service financial planner who can offer you an objective
review of your insurance options. When you decide on what you want, there are many
solid insurance companies to choose from. Consult your library or an independent
insurance professional for companies with the highest ratings from the four ratings
agencies: AM Best, Duff Phelps, Standard & Poor's, and Moody's.
Summary
- Term insurance is basic, inexpensive coverage with premiums that increase over time
and have no cash value.
- Consider a term policy that is renewable and convertible to whole life should your
needs change.
- Whole life provides level coverage with level premiums. A portion of those premiums
goes into tax-deferred savings.
- Check rates on whole life policies and compare them to other investment opportunities.
- Variable life offers control over your investments.
- Premiums on variable policies are fixed, but face value and the value of your investments
can fluctuate.
- Universal life offers more investment options, but is highly sensitive to interest
rate changes. Universal variable life is highly flexible, but offers no guarantees
beyond the original face value.
- Insurance needs are based on income replacement and personal preferences.
Souce of this Material:
Yahoo Financial
