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
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
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,
although loans reduce the policy's death benefit and cash value,
and may trigger a taxable event if the policy lapses.
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 with
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. You'll receive
an annual statement that details cash value, total protection,
earnings, and fees.
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.1 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
Universal Variable Life insurance is the most
aggressive type of policy. Like variable life, you can choose from
a variety of investment options. 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
- Face Value -- The original death benefit
- Convertibility -- Option to convert from one
type of policy (term) to another (whole life), usually without a
- 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 10
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 may go 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
housing, health care, food, clothing, transportation expenses, etc.
This represents the amount 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
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.
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
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.
Life insurance is an important component of a sound financial
plan. Buying insurance involves asking a variety of personal
lifestyle and financial questions. There are various online tools
available to help you assess your insurance needs, but working with
a trusted financial professional with experience in the insurance
industry may be beneficial. The financial professional can offer
you a review of your insurance options and provide insight on the
insurance coverage that best suits your needs.