The best way to explain what a Life Insurance policy is as a replacement for your income in case something were to happen to you. Life insurance is an unusual product because most people are used to buying something and then being able to use it immediately. Many Americans proclaim that life insurance is too expensive to buy. The irony is that these same households who choose not to purchase life insurance cannot financially surive another month without their primary earner. Before we explain the types of policies available, let's break down 5 of the most common myths surrounding Life Insurance:
Even if you are in this group, life insurance is important. Life insurance may help any beneficiary you choose pay off your debts (like some private college loans, for instance) if you pass away. Planning early not only helps protect your loved ones from burdensome expenses, but it also gets you started on a financial plan for the future.
Stay-at-home parenting is a full-time job. Imagine the tens of thousands of dollars it would cost each year to replace the services you provide each year. Necessities such as transportation, child care, home maintenance, and cooking may be covered by Life Insurance if you were to die.
There are many additional expenses to consider after your death which will fall onto your loved ones. Expenses range from funeral and burial to your home's mortgage. These expenses can potentially add unmanageable burden to your loved ones that could be avoided through purchasing a life insurance policy.
Life Insurance is not an investment. By definition, life insurance is insurance. It is a means of providing income for your family if you were to die.
Your health matters a lot when you are paired with a life inusrance policy. Inevitably, non-smokers and individuals considered low-risk will pay lower premiums than those who are high-risk. It is also important to note that waiting for life insurance prices to go down is not a recommended strategy because life insurance generally goes up in cost as you age.
We're glad you asked as there are many different life insurance policies to choose from including new products that actually let you collect money before your death. Here is a concise list of what to expect:
One of the most commonly used policies is term life insurance. Term insurance can help protect your beneficiaries against financial loss resulting from your death; it pays the face amount of the policy, but only provides protection for a definite, but limited, amount of time. Term policies do not build cash values and the maximum term period is usually 30 years. Term policies are useful when there is a limited time needed for protection and when the dollars available for coverage are limited. The premiums for these types of policies are significantly lower than the costs for whole life. They also (initially) provide more insurance protection per dollar spent than any form of permanent policies. Unfortunately, the cost of premiums increases as the policy owner gets older and as the end of the specified term nears.
Variable universal life insurance combines the features of universal life with variable life and gives the consumer the flexibility of adjusting premiums, death benefits and the selection of investment choices. These policies are technically classified as securities and are therefore subject to Securities and Exchange Commission (SEC) regulation and the oversight of the state insurance commissioner. Unfortunately, all the investment risk lies with the policy owner; as a result, the death benefit value may rise or fall depending on the success of the policy's underlying investments. However, policies may provide some type of guarantee that at least a minimum death benefit will be paid to beneficiaries.
Variable life insurance is designed to combine the traditional protection and savings features of whole life insurance with the growth potential of investment funds. This type of policy is comprised of two distinct components: the general account and the separate account. The general account is the reserve or liability account of the insurance provider, and is not allocated to the individual policy. The separate account is comprised of various investment funds within the insurance company's portfolio, such as an equity fund, a money market fund, a bond fund, or some combination of these. Because of this underlying investment feature, the value of the cash and death benefit may fluctuate, thus the name "variable life".
Whole life insurance provides guaranteed insurance protection for the entire life of the insured, otherwise known as permanent coverage. These policies carry a "cash value" component that grows tax deferred at a contractually guaranteed amount (usually a low interest rate) until the contract is surrendered. The premiums are usually level for the life of the insured and the death benefit is guaranteed for the insured's lifetime. With whole life payments, part of your premium is applied toward the insurance portion of your policy, another part of your premium goes toward administrative expenses and the balance of your premium goes toward the investment, or cash, portion of your policy. The interest you accumulate through the investment portion of your policy is tax-free until you withdraw it (if that is allowed under the terms of your policy). Any withdrawal you make will typically be tax free up to your basis in the policy. Your basis is the amount of premiums you have paid into the policy minus any prior dividends paid or previous withdrawals. Any amounts withdrawn above your basis may be taxed as ordinary income. As you might expect, given their permanent protection, these policies tend to have a much higher initial premium than other types of life insurance. But, the cash build up in the policy can be used toward premium payments, provided cash is available. This is known as a participating whole life policy, which combines the benefits of permanent life insurance protection with a savings component, and provides the policy owner some additional payment flexibility.