Life Insurance 101
As we get older and start a family, life insurance becomes more important than ever. We start to worry about how our loved ones will be cared for if a death occurs unexpectedly.
The only problem is that buying life insurance can be overwhelming with all the information that is out their now. In this article we are going to go over why you need life insurance, break down the policy terms, and review the different types of policies offered.
After reading, you will be ready to tackle the task of buying life insurance.
Reasons to Own Life Insurance
The question we get alot is:
That question is usually easy to answer. If you have loved ones that depend on you or debt that needs to be repaid if you die, then you need life insurance.
The five major reasons to own life insurance are:
To Protect Family and Loved Ones
If you have a loved one that depends on you financially, whether it be a spouse or special needs child, then life insurance is a must.
You will want enough life insurance to cover the costs of daily life expenses like childcare, cooking, cleaning, and laundry. Life insurance is especially important for parents with young children who depend on their spouses income for support.
Pay off Outstanding Debts
A reason to own life insurance is to cover everyday living expenses. You should also have enough to cover any outstanding debts, such as mortgages, credit cards, or business debt.
Other expenses could include burial costs or final expense bills. You will not want to leave this burden on your loved ones and add to the emotional burden already being suffered.
To Leave an Inheritance
Most people don’t have huge assets to pass on to their heirs, but if you own life insurance, you create an instant tax-free inheritance. This is a great way to set up your children or grandchildren for a successful financial future.
To Cover Children’s College Expenses
Buy/Sell Agreements
If you are a business owner with a partner, whether family or not, you need a buy/sell agreement. Life insurance is used in buy/sell agreements all the time. The proceeds are used by the remaining partner to buy the business from the deceased partners family.
This allows for a clean transfer of the business while protecting the deceased’s love ones.
Peace of Mind
Probably one of the most important reasons to own life insurance is the peace of mind of know that your family will be taken care of in the event of a tragedy. It’s hard enough emotionally to get over a death, but adding a financial burdens can lead to disaster for you loved ones.
How Much Life Insurance Should I Buy?
This can be a loaded question. We like to use the DIME formula to calculate how much life insurance should be purchased. DIME stands for debt, income, mortgage, and education. These 4 areas should be considered when calculating your needs.
Debt and Final Expenses
Add all your debt up and estimate any funeral expenses. Exclude any mortgages.
Income
This can be tricky, most experts say multiply your salary by 10. Even this may not be enough depending on how many children you may have and if any have special needs.
Mortgage
Leave enough life insurance money to pay off any mortgages you might have.
Education
With the cost of education rising, it’s always good to estimate the cost of sending your children to college on the high end. Who knows what it will actually cost in 10 or 15 years.
While the DIME formula is comprehensive, it doesn’t account for savings or life insurance coverage already inforce.
Life Insurance Terminology
Before we get started on the different types of policies offered, lets get to know some basic life insurance terms:
Common Life Insurance Terms to Keep in Mind
- Policy: It’s the legal contract between you and the insurer. It outlines every detail that has to do with the life insurance coverage including the names of parties involved, terms, costs, fees and more.
- Owner: This is the person who’s entering into the contract with the insurance provider.
- Insured: The insured is simply the person whose interests/life are protected by an insurance policy.
- Insurer: This is the insurance company that offers or issues a policy to the owner/insured.
- Beneficiary: The beneficiary is the entity who is entitled to receive the life insurance proceeds following the death of the benefactor. As an insured, you can choose to name multiple beneficiaries, contingent as well as tertiary beneficiaries.
- Death Benefit: This is the lump sum tax free payout that’s given to the beneficiary of a life insurance policy when the insured passes on.
Types of Life Insurance Policies
What’s the first thing that hits your mind when you hear life insurance policies? Well, if you’re like other people out there, you’re probably thinking term, and we can’t blame you for that!
Term life insurance is the most popular of other life insurance options but of course, you should be aware that there are still other choices available to you.
Now, if you’re ready to choose a life insurance policy, it’s crucial to get a better understanding of what you need and know exactly how it’s going to work for your situation.
Once you get familiar different types of life insurance policies (basically term and permanent), you’ll be able to better customize the coverage to meet your needs.
The good news? In this article, we’re going to explore just about everything you need to know! So of course, now you only must keep up. Let’s get started.
Now let’s go straight to the different types of life insurance policies available to you. As mentioned earlier, term and permanent houses several different types to choose from. Let’s dive in!
What is Term Life Insurance?
Term life insurance is the most popular types of policies available on the market right now. Essentially, this type of life insurance provides you with death benefit protection and has no cash value build up.
Of course, this is precisely why term life insurance is affordable to just about everyone and the first choice for anyone looking to get covered. We consider term a temporary answer to a permanent problem.
For the most part, term life insurance is bought for a specific period — it could be for 10 years or even as long as 30 years.
Moving forward, it’s important to note that when buying a level term life insurance policy, the premium will remain level throughout the term period. Term life insurance is going to have a much lower premium than permanent life.
The one downside to term insurance is that the coverage will expire at some point depending on the length/years you chose. Term policies do allow you to convert your policy to something permanent before the end of your coverage period without showing evidence of insurability.
But of course, you should be aware that premium on a new life insurance policy (at this time) will be higher.
Types of Term Life Coverage
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Level Term Life
This is the most common term policy sold today. The premium and the death benefit remain level for the coverage period that you chose. The coverage periods can range from 10-30 years.
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Decreasing Term Life
Decreasing term performs just like it sounds. The death protection decreases each year till it reaches zero. These policies are mainly used to cover home mortgages, business loans, and in some cases, personal loans.
The main disadvantage is that while the benefit/death protection decreases, the premium stays the same. Not really a good deal!
Permanent Life Insurance Coverage
The name says it all — permanent life insurance provides you with lifelong protection along with the capacity to accumulate cash value on a tax-deferred basis, and if done correctly can be withdrawn tax-free.
The key point to keep in mind is that a permanent life insurance policy covers you for your entire life (to age 120). Most permanent policies come with a guaranteed premium, but not all. It is very important question to ask when inquiring about a permanent policy.
Types of Permanent Life Insurance Coverage
First off, whole life is the most basic of all types of permanent life insurance coverage. Whole Life is was first sold in the United States in 1760. These policies offer a death benefit alongside with cash value accumulation.
These types of policies come with guaranteed premiums which are set according to your age, health, and amount of insurance you chose. Essentially, if you choose this type of life insurance policy, you’re agreeing to pay an amount in premium on a regular basis for a given death benefit.
These policies also have the cash value accumulation feature. All whole life policies come with the guaranteed cash value which is set by the insurance company which are called Non-Participating policies.
Participating whole life policies also have the guaranteed cash value but also kicks out dividends each year based on the company’s portfolio. These dividends can be withdrawn, used to buy extra insurance, or can just sit there and accumulate for a rainy day. The one downside to whole life is that is can be pricey.
Looking to get a permanent life insurance coverage that offers more flexibility than whole life? If so, you’ll want to learn more about Universal life insurance. The first thing to keep in mind is that this type of policy gives you flexibility.
Unlike whole life insurance, universal life allows you the flexibility to change how much you pay in premium, but you can also decrease your death benefit if necessary. There are 4 types of universal life policies and believe me they are not all the same. They are:
- Traditional/Non-Guaranteed UL
- Guaranteed Premium UL
- Indexed UL
- Variable UL
As you can see there are a lot of variations to the universal life policy and can be quite confusing to the average shopper. Check out our blog to get an in more depth look about how each of these policies work. The one question that should always be asked if looking at purchasing a universal life policy is…