Life Insurance
Life Insurance – The Affordable Way to Say I Love You.
Life insurance is one of those things that most people know they need, yet many people put off buying it, permanently. In fact, 95 million Americans between the ages of 25 to 65, that’s over 40% of all the eligible population, have no life insurance coverage at all.
And younger people? Yes, they know they need life insurance but many overestimate the cost of insurance by an average of 213%. The reality is that life insurance premiums are less than most people think.
Planning Ahead: Life Insurance Basics
"My mom was young when we lost her, but she had planned ahead and had life insurance. Thanks to her, we were able to grow up in the house she could never afford." – Natasha M.
Life insurance is more than just a way to plan for the unexpected. It is a demonstration of love and commitment to the ones that depend on you. In its simplest form, a life insurance policy lets you (primary insured) leave money to your loved ones (beneficiaries) when you die.
The policy owner can choose anyone to be the beneficiary, and can usually change that beneficiary at any time. Contingent beneficiaries can be added in the case that the primary beneficiary is no longer alive.
As long as the policy is active (in-force), the company pays the face amount when you die. The face amount is paid to your beneficiaries tax-free. This means the beneficiary does not have to worry about paying taxes on the amount he or she receives.
How Much Do I Need?
"Dad's last wish was that I go to college - and he made sure that the money was there for me." - John W.
Life insurance allows you to leave a legacy to the ones you love. Determining the amount you need and how long you need coverage is crucial to finding the best policy for you and your loved ones.
Here Are Several Things to Consider
How much will your beneficiaries need to cover immediate costs, such as funeral expenses and unpaid debt (mortgage and car payments, utility bills and so forth)? A good rule of thumb is to start at 15,000 and work your way up or down, depending on your situation.
If you are the primary earner of the household, your income will need to be replaced. How long will that income need to be provided? 20 years? 30 years?
If you have children that you want to attend college, be sure to account for their tuition costs.
Do you have debt? Life insurance can be a good way to pay debts off.
After you determine how much you need, be sure to subtract existing investments and retirement accounts.
Once you have a general number, make sure its an amount to makes sense for you and you can qualify for.
How Much Can I Qualify For?
Applying for life insurance doesn't guarantee that you will receive the amount you applied for. Underwriters review every application to make sure the amount is not too high and that you are healthy enough to be covered.
Face Amount Too High
Having too much life insurance is a red flag that underwriters look for. It could indicate that the insured is engaged in an unreported high risk activity or has received unreported health information. If your life insurance is too high, the underwriters will often only approve a lower amount that they feel is fair.
Poor Health
Most applications contain a series of health-related questions, and some require blood and urine tests. Higher face amount policies may even require EKG's and copies of your medical reports. If you have serious health issues, smoke or use tobacco products, or have other unhealthy habits, your premiums may be increased to cover the additional risk or you could be denied coverage.
High Risk Activities
Some occupations and activities have an increased mortality risk. For example, people with occupations in mining and oil exploration are likely to pay higher premiums. Sports and hobbies such as racing, underwater diving, piloting a private aircraft or skydiving are riskier. In these cases, exclusions may be added to the policy that will reduce the face amount if the insured is engaged in one of these activities at the time of death.
Choosing Your Policy: Types of Life Insurance
"I've never made choices based on money - I always trust my gut." David James Elliott
Making sure you have the right kind of policy is important because everyone's needs are different. While many companies offer life insurance to their employees, this coverage is almost always terminated when you leave the company or retire. Individual life insurance, however, falls into two general categories: permanent life insurance and term life insurance.
Permanent Life Insurance
As the name suggests, permanent life insurance is designed to stay in-force for the lifetime of the insured. When most people think about life insurance, this is the concept that comes to mind. These policies are designed to meet financial obligations or provide an inheritance to the beneficiaries. They are often used to fund organizations, set-up scholarships, give to educational institutions or any number of philanthropic endeavors as well.
Permanent life insurance comes in many varieties and premiums can be paid in a number of ways depending on the type of policy. Specific policy types include universal life, variable life, variable universal life and whole life.
Universal Life Insurance (UL)
Universal life is a kind of permanent policy that has a cash value component. This cash value is often based on a fixed or variable interest account, and this account is used to pay the costs of the policy. As long as there is enough cash value, the policy will stay in-force. Premiums are flexible, meaning you can over or underpay premiums as long as there is enough cash value.
This cash value can be borrowed at a low interest rate by the policy owner as long as the policy stays in-force. Over-funding this account (while there are limits to the maximum amount allowed) can be an effective way to keep your funds safe.
Variable Life Insurance
Variable Life insurance (VL) can be either permanent or term, depending on how it's funded. The face amount or duration depends on the cash value of the policy. The policy owner selects securities-based sub-accounts (accounts similar to mutual funds) to invest in, and can allocate an amount or a percentage of premiums for each account. The cash value of the policy is largely determined by the investment performance of these underlying securities.
Variable life and variable universal life policies contain securities and are regulated by FINRA in addition to state insurance departments.
Variable Universal Life Insurance
Variable Universal Life (VUL) provides permanent life insurance coverage, flexible premiums, and the option to allocate premiums to a variety of sub-accounts (funded by underlying securities). The cash value is used to pay the insurance costs and fluctuates with investment performance.
Money from sub-accounts can be borrowed at a low interest rate without paying taxes on the earnings from positive investment results. However, because of the investment component, VL's and VULs have the risk that investments will perform poorly and the policy may lapse.
Whole Life Insurance
Whole life insurance is one of the oldest types of insurance, first seen in the United Statesin the 1830's.
Whole life offers permanent life insurance coverage. The premiums are allocated to the company's general account (similar to a bank account). There is little risk associated with these policies; however, the cost is higher than other types of permanent life insurance.
Term Life Insurance
Term life insurance policies stay in-force for a set number of years. Typically, they are offered in 1, 10, 15, 20, 25 and 30 year terms, or until the insured turns 65. Premiums are paid monthly, quarterly, semi-annually or annually. The bulk of the premium payments cover the cost of insurance. Term policies have no cash value or surrender value.
Return of Premium Term
A newer type of policy is the Return of Premium policy. These are similar to traditional term policies, with the exception that at the end of the term period, the premiums are returned to the policy owner. The costs are higher than a regular term, but these are popular because the owner receives her premium back when the policy terminates.
Flexible and Cost Effective
Term life insurance is flexible and cost effective, making it a good choice to meet a variety of needs. Here are three popular uses:
- Protection for individuals or families while their children are young
- Mortgage protection for the length of the home loan
- Coverage until retirement
Other Types of Life Insurance
Individual life insurance is the most popular kind of policy. After all, it meets people's financial needs and is an effective way to leave a legacy to the next generation. However, there are other types and uses. These are just a few.
Credit Life – A life insurance policy, often used as collateral for a loan, with a creditor assigned as the beneficiary. If the insured dies before the creditor is paid, the death benefit pays the remaining debt before being distributed to any other beneficiaries.
Group Term – This is a common benefit that provides a base-level of life insurance protection for employees. Employees are able to increase their coverage at a small cost. However, once the employee leaves the company, the coverage ends.
Key Person – A policy purchased by a business to financially protect against the loss of a key employee.
Important Terms to Understand
"I wish I had an answer to that because I'm tired of answering that question." - Yogi Berra
The following definitions will help you understand the basics of life insurance.
Actuary – A person who calculates the costs of insurance products based on the probabilities that an insurable event will happen.
Adverse Selection – The action of a person who purchases or attempts to purchase an insurance policy because they are likely to face an insurable event.
Agent – Someone who sells, services or otherwise represents a given insurance company. Agents can be independent (working from several companies) or captive (working for one company only).
Annuity – A contract providing income for a specific period of time or for a given amount of funds. Payments to beneficiaries can often be annuitized.
Beneficiary – An individual who is designated to receive payments from an insurance policy, investment, trust or other contract.
Broker – A person who receives commission income from the sale and distribution of insurance policies. Brokers are able to sell policies from more than one insurance company.
>Cash Value – The cash amount available in the policy.
Cash Surrender Value – This is the amount that the owner will receive if the policy is canceled.
Contestability Period – The period of time that an issuing company can contest the payout of the policy. For life insurance, this is generally two years after the effective date.
Contingent Beneficiary – This recipient(s) receives the proceeds if the primary beneficiary is deceased.
Effective Date – The date when a policy is in-force. This can be different than the issue date.
Face Amount – The death benefit amount of a life insurance policy. This is the amount that is paid to the beneficiary.
Flexible Premium – A premium that can decrease or increase based on the cash value of a policy.
Grace Period – The time after the payment due date in which the policy owner can make a premium payment before a policy lapses.
Insurable Event – An event that can be covered by insurance. For life insurance, an insurable event is death.
Insurable Interest – A right or relationship with the insured that will incur a financial loss if that person dies. Family and dependents are primary examples. A person or entity must have insurable interest in order to have a policy issued for an individual.
Irrevocable Beneficiary – A beneficiary that cannot be changed by the policy owner without that beneficiary's consent.
Issue Date – The date a policy is issued. This can be different from the effective date.
Lapse – When the insurance policy ends because the premiums have not been paid or the cash value is not enough to keep it in force.
Level Premium – A premium amount that remains the same throughout the life of the policy.
Minimum Premium Amount – The least amount that can be paid for the policy to stay in-force.
Mutual Insurance Company – An insurance company owned by policyholders.
Primary Beneficiary – This is the recipient(s) of the life insurance proceeds. With most policies (there are some exceptions), the beneficiary can be changed at any time and for any reason.
Rider – An additional feature, coverage amount or contract modification made to the life insurance policy. This may be an additional insured person or coverage amount for specific term.
Stock Insurance Company – An insurance company that is owned by stockholders.
Substandard Risk – An insureds’ higher than average risk that results in higher premium amounts, reduced coverage or denial of insurance.
Underwriter – The person who reviews and determines the risk of an insured.
Sources:
Limra - Industry trade group
National Association of Insurance Commissioners