Life Insurance: The Basics

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Don’t have life insurance? You’re not alone. Over 100 million Americans don’t have a policy, according to Life Happens, a nonprofit focused on the insurance industry. And even if you do have it, the policy you own may not be appropriate for your current circumstances. “Life insurance needs change over time,” notes Paul Felsen, owner of Felsen Insurance Services in Denville, New Jersey. “Any life change, like a marriage, a move, or a child going to college may be a good time to look over the insurance you have.”

Life insurance not only provides protection to your loved ones in the event of your death, it can be a valuable tool to add to your investment arsenal. Here, everything you need to know about life insurance, right now.

What is life insurance?

Broadly speaking, life insurance protects your loved ones by ensuring they have enough money to pay any bills, including your funeral expenses, once you pass away. You pay a premium and, upon your death, your beneficiary gets a lump sum, called a death benefit. Usually tax-free, this money can go toward funeral expenses, medical bills, and ongoing bills throughout their life, including mortgage payments and tuition fees.

But today, more and more insurance products can act as a tax-deferred investment vehicle for you while you’re still alive. You can also borrow against your policy for certain financial moves, such as buying a house or paying college tuition. Some policies also allow you to take out a certain percentage of your death benefit if you have a catastrophic illness or medical event, such as a heart attack, stroke, or certain cancer diagnoses.

Who needs life insurance?

In short, just about everyone. Of course, anyone who is a family breadwinner or has dependent children needs life insurance. But take a big-picture look at your family situation. For example, it can be smart for a spouse who doesn’t work outside the home or a retiree to have insurance, too.

“People often equate life insurance with lost income, but it covers so much more than that,” notes Felsen. “Even if you and your spouse are retired, expenses will incur when one of you dies, including the funeral expenses, but also potential relocation expenses, expenses related to your own continued medical care, or expenses related to your children, even if they’re grown.”

And your 20-something child may be single and renting, not owning, but encouraging them to buy life insurance (or even helping foot the bill for premiums, if you can afford it) can be a smart move. “It’s a good idea for young people to get life insurance, especially since rates are likely to be low if they’re in good health,” notes Felsen. Not only that, but owning a policy sets up a 20-something for a lifetime of insurance knowledge, so they’ll be able to keep up their policy or change their policy to suit their needs as they get older.

What kind of life insurance should you get?

Many companies offer policies for their employees, while some offer supplemental insurance options for a spouse or dependents. While these supplemental insurance policies can be less expensive than purchasing an individual policy, the policy may be voided once you leave the company. That’s why it’s usually best to explore individual policies, which you can customize to suit your needs.

Broadly speaking, the options can be broken down into three categories: term life insurance, whole life insurance, and universal life insurance. Of these three, universal and whole life insurance are known as “cash value” products, which means you can cancel the policy at any time and withdraw the cash value of the policy.  

  • Term life insurance. With this type of insurance, you choose a term—10, 20, or 30 years are common terms—in which the insurance policy will be active. At the end of the term, you will need to renew the policy at a new rate. Term life insurance tends to be the least expensive insurance product offered—depending on your age, health, length of term, and benefit amount, some policies can be purchased for $30 or so a month, while whole life insurance can cost $7,000 or more a year, or over $800 a month.
  • Universal life insurance. This is a cash value policy. Unlike term life insurance, you can earn interest and borrow against the accumulated cash value of the policy without tax implications. The premiums on this policy can fluctuate, and they can also be 10 times (or higher) than a term policy, because a portion of the amount of your premiums are going into investments.
  • Whole life insurance. Another cash value policy, this policy has fixed premiums, which are invested and allow the policy to build a cash value you can use while you’re still alive. As with universal life insurance, these policies can be 10 or 20 times as expensive as term life insurance, but the advantage is the cash value the policy builds, as well as the option of cashing out the policy at any time.

How do I buy life insurance?

Life insurance options can be complicated. In fact, according to Life Happens, 54 percent of Americans view purchasing it as complicated—about on par with the percentage of Americans stymied by the tax code. And just as you may go to a tax pro to help you prepare your tax return, talking to an insurance broker or agent can help you sort out the best option for you. 

If you’ve never had life insurance before or depended only on employer benefits, you may think you’ve missed the life insurance boat, especially if you’re nearing retirement. But that’s not the case. While it is true that the premiums of many products are directly tied to your age, a life insurance policy at any age can offer a host of benefits, including peace of mind to yourself and your beneficiaries. Contrary to popular assumption, life insurance products—including term life insurance—can be purchased by those over 65, so it truly is never too late to consider purchasing a policy. For example, a product called “final expense insurance”—available in fixed-sum amounts up to a $75,000 cap—has minimal underwriting and is designed to cover final expenses only.

How much life insurance do I need?

How much life insurance you need depends on your lifestyle, expenses, and bills right now, as well as your family’s needs in the future. One common rule of thumb is to multiply your annual income by 10, but this broad marker may not reflect your individual needs, which is why it may be helpful to review your needs with an insurance broker. For example, families who have college-bound kids may want to add an additional $100,000 per child to that figure to cover potential future tuition expenses.

How to pick your beneficiaries

The beneficiary of your policy will be paid the death benefit when you die. You name a primary beneficiary and a contingent beneficiary—who will become the beneficiary only if the primary beneficiary passes away before you.

It’s also possible to name multiple beneficiaries—say, dividing among several relatives—or to have the entire benefit go to your estate (which may have tax implications) or to a trust. An insurance agent can help you sort through options, while a financial planner or estate attorney, if you have one, can help you figure out the smartest strategy for your family.

Just as your life evolves, so too do the people who are best suited to be your beneficiaries. So it’s smart to review your beneficiaries any time you have a life change, like a divorce, remarriage, or death in the family.

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