Life insurance can be an important tool in your overall financial planning. But what you need and what you need it for can change over the different stages of your life.
Let’s talk about why you may need life insurance, different kinds of life insurance policies, how to figure out how much coverage you may want, and some additional considerations as you look at your options.
The most basic part of any life insurance policy is the death benefit. When the policy owner dies, a death benefit is paid to the named beneficiaries of the policy. This could be a spouse, children, grandchildren or others.
You may want to carry a life insurance policy (or multiple policies) to accomplish one or more of the following:
In addition to the death benefit, some types of policies also have a cash value component that can be tapped while the policy owner is alive for a variety of purposes, including withdrawing the cash, reducing policy premiums, or taking a loan against the policy’s cash value.
Life insurance comes in many forms, and you want to make sure you’re carrying the best kind of policy for your needs.
A term policy is sometimes referred to as pure life insurance. A term policy offers coverage for a specified length of time, such as 10 years, 20 years, or 30 years. As long as the premiums are paid, the coverage and the death benefit stay intact. When the term ends with the policy holder still living, however, the policy expires with no payout.
Term policies usually offer a larger death benefit than many permanent policies for a lower premium, so they may be a good choice if you only need the payout in a specified time period. When a term policy expires, you may have the option to renew the policy for an additional term, to purchase a new term policy, or to convert the term policy to a permanent life insurance policy.
You can also have multiple term policies, and some people ladder them so that they overlap and expire at different times. One risk of buying a term policy is that your health situation will likely deteriorate while owning the policy. If you need to purchase an additional policy once the term policy expires, the insurance company might charge a much higher-than-normal premium, or possibly deny coverage altogether.
Unlike term policies, permanent life insurance policies have no expiration date; so long as the premiums are paid, the policy stays in effect. They do, however, come in two related but distinct flavors.
In a whole life insurance policy, the death benefit and the premium will remain the same over time, and the policy will remain in force as long as the premiums are paid. The policy builds cash value each year at a guaranteed interest rate, and this cash can be used to pay some or all of the future premiums, or can be borrowed by the policy owner. In that case, the death benefit will be reduced by any outstanding loan amount, and the loan will incur interest.
Universal life insurance policies allow more flexibility on premium payments, but the cash value growth is based on market movements, making them less predictable. For example, indexed universal life insurance generally ties the interest rate on the cash value to an index like the S&P 500, or another type of index. Similarly, variable universal life insurance allows the policy owner to invest the cash value in a separate account. These policies can be designed with a flexible premium, and a level or increasing death benefit.
Determining what kind of a death benefit you need will depend on factors like your stage of life and the kinds of financial goals life insurance is fulfilling for you.
Start with this question: What happens to your family from a financial standpoint in the event of your death? If you’re still working, your family might need the death benefit to cover ongoing expenses that were previously covered by your salary. If you’re older or experiencing a long illness, the death benefit might be needed to cover unreimbursed medical expenses. What amount would cover your family’s needs?
The death benefit can also be used to ensure that you pass on funds to your heirs. In addition to covering your family’s needs, what extra amount would you want available to distribute to your loved ones?
It’s important to note that you can’t necessarily buy any amount of life insurance you want, especially not at a price you want. Insurance companies use underwriting to determine how much coverage they’ll offer, based on your specific circumstances. But it’s also not unheard-of for brokers to offer more than you need, so knowing what amount would be ideal for your needs can help you find the best available solution.
As you’re investigating buying life insurance, you’ll want to think through the cost, the stability of the issuing company, and how the policy is owned.
The cost or premium of a life insurance policy is determined by a number of factors. These include:
As you’re considering policies, you’ll want to balance the cost of the premiums with the overall benefit to you and to your family.
Ideally, you’ll hold your life insurance policy for decades. That means you need the company you purchase the policy from to be around decades from now to pay out the death benefit.
That’s why it’s important to check out the financial health and financial health ratings of the life insurance company before you purchase a policy. While the state insurance commissioner may offer some protection against an insurer who goes bankrupt, chances are the death benefits won’t be paid in full.
There are (at least) three people involved in a life insurance policy besides the life insurance company: the person insured, the person who owns the policy, and the beneficiary or beneficiaries of the policy.
Often, the insured will also be the owner of the policy, and thus responsible for the premiums.
The policy may also be owned by someone other than the insured. For example, a spouse may take out a life insurance policy on their partner, paying the premiums and receiving the benefits when that spouse dies.
A policy may also be owned by a trust. This might be part of an overall estate planning arrangement designed to ensure that assets are passed properly to beneficiaries and that taxes are minimized.
Life insurance can be a versatile and important tool for your financial and estate planning. But that doesn’t mean you need to purchase the maximum available policy, despite what a broker might tell you. Focus instead of figuring out what benefit you and your family need, what you can afford, and what kind of policy will best serve your needs.