A topic that's not an easy one to talk about is life insurance. Adding to this stress are aggressive agents, which can make this subject difficult to discuss in an objective manner. As consumers, the most important fact to keep in mind is this: a life insurance policy is an important part of every family's financial contingency plan.
Financial Planning and Life Insurance
In fact, life insurance plays a very important role in every family's financial future. No one likes to think about it, but when it's needed, life insurance becomes an asset that can help eliminate the financial burden or pain a family and loved ones might feel from the sudden loss of income.
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While insurance policies are typically purchased to provide a monetary benefit to beneficiaries, it can play other roles too such as:
Providing funds to pay for the deceased person's funeral.
Insuring against a particular need. For example paying off a loan such as a home mortgage or student loan.
Providing funds to pay income taxes or other final obligations due on an estate.
Compensation to a company in the event of a loss of a key employee, or to provide funds to purchase the remaining share of a business from a partner.
Once the reasons for purchasing life insurance are clear, it should be easier to figure out just how much coverage is needed. A policy should be just large enough to meet the needs identified earlier. To be over insured is just as bad as being underinsured, since excessive premiums can take money away from other long range financial savings goals.
In the next several sections we're going to discuss the specific types of insurance policies on the market today, and how they're bundled, or sold, by insurance agents. We'll also briefly discuss some of the more interesting features of each plan.
Term Life Insurance Policies
Term life insurance is an affordable way to provide financial security for loved ones. By nature, term insurance is usually guaranteed for "terms" or intervals such as 10, 20 or 30 years. It's also designed to provide for a one-time benefit. Moreover, unlike whole life and universal life policies (discussed later), term insurance does not have a cash value.
The one true risk this coverage carries with it is the fact the policyholder might be uninsurable when the coverage finally expires. This can happen due to the onset of an illness or a medical condition that developed over time. One way around this is to purchase one-year renewable term policies, where the premium escalates each year, as the policyholder grows older.
Whole Life Insurance Policies
A whole life insurance policy combines the benefits of a term policy with that of an investment that has a cash value. During the early years of the policy, a smaller portion of the premium will go towards the cost of providing a life insurance benefit, and a larger share to the cash balance account. As the policyholder ages, the cost to provide insurance will rise, and a smaller percentage will be allocated to the investment account.
In addition to providing the policyholder with a cash value, certain whole life plans also provide for dividends, which are paid when the actual cost to provide coverage turns out to be less than assumed in the insurance carrier's original forecast.
Because of the way premiums are calculated, the policy is considered permanent life insurance. A permanent life insurance policy is one that will continue to provide coverage as long as the owner makes their annual premium payments.
Universal Life Insurance Policy
Universal life insurance policies also provide permanent life insurance, in addition to carrying a guarantee against premium lapse. These policies also frequently carry a guaranteed minimum interest crediting feature, and a potential for a tax-deferred cash value fund accumulation.
There also the most flexible form of life insurance available today. It's possible to find universal policies that offer multiple benefit options, such as a survivorship plan that covers two individuals. Because of this flexibility and accumulating cash value, they're often used in estate and business continuity planning.
Cashing in a Life Insurance Policy
There are times when a policyholder needs access to the cash value of their insurance policy, which is often referred to as the surrender value. When cashing in a life insurance policy, any gain will be taxed as ordinary income. The gain on a policy is calculated as the difference between the premiums paid and its cash value.
Some insurance plans allow policyholders to take loans out against the cash value of their policies, and even transfer ownership of the policy to another person. Anytime a policy is cashed in or sold, there can be federal and / or state income tax consequences or serious impacts to an estate. Always consult a tax professional before cashing in, transferring, or selling a policy.
Advances on Life Insurance
There are times when a policyholder might want access to their life insurance benefit while they're still alive. A rider to the policy can allow for access to this money; however, certain conditions must be met, for example:
The insured might need to be confined to an eligible nursing home for a certain length of time, and expected to be permanently confined.
The insured might need to be terminally ill, and be expected to live less than six months.
The insured might need a vital organ transplant, and have six months or less to live without the transplant.
Such advances on life insurance are sometimes referred to as Living Needs Benefits. The insured usually has to meet a number of conditions, and the insurance policy must be in-force as of the settlement date. Lapsed policies are usually not eligible for an advance.
The exact procedure for an advance on a life insurance policy will also vary by state. For example, in Massachusetts a Living Needs Benefit is not available, and cannot be added to a policy. Advances on life insurance are also not available in Minnesota to new purchasers over age 65 until the policy has been in force for one year. The nursing home option is not available in New York or the District of Columbia.
Evaluating Life Insurance Policies
It's fairly easy to compare term policies; the premiums as well as the benefit should be clear. As long as the features are identical, it's possible to make a direct comparison of the premiums.
Evaluating whole life and universal life insurance policies is not so straightforward. Each insurance carrier will make certain assumptions, guarantees, and projections in their policies, for example:
Cash Value: What are the projections for the cash value, and what is the rate of return assumed in those projections? Do those rates of return seem reasonable?
Policy Dividends: Are the dividends used in the projections in line with dividends paid in the recent past?
Borrowing / Loans: Do those projections use policy loans to help pay premiums?
Surrender Charges: How much does the company charge if a policy is terminated?
Finally, it's important to understand whether or not the insurance company is stable and financially strong. There are independent companies that rate these organizations in terms of financial strength. Those rating companies include A.M. Best Company, Standard and Poor's, and Moody's Investor Service.
Buying Life Insurance
There are four ways to purchase life insurance: through an agent, through the mail, over the internet, or through a group. Most people purchase their insurance through an agent that earns a commission based on how much insurance they sell. That's why it's important to know how much coverage is needed before having this discussion. A good agent will walk their clients through the process of figuring out how much coverage they need, and will not rush anyone into signing a policy.
The second most popular means of purchasing life insurance is through an employer. These group plans can oftentimes be less expensive than an individually purchased policy.
Replacing Existing Insurance Policies
Finally, insurance agents have a duty to ask about a client's current life insurance coverage. There are rules and regulations in place that are designed to protect consumers and every agent should follow those guidelines once it is known there is an existing policy.
For example, consumers should never cancel an existing policy before the new one is in effect. There may also be "contestable periods" where a new policy may not automatically pay a claim. Agents need to explain these and all other risks involved with replacing an existing insurance policy.
Life Insurance Calculators
We've developed several tools that can help users figure out how much life insurance they might need. This selection of calculators includes:
Simple Life Insurance Calculator: takes a very simple approach to figuring out "roughly" how much life insurance is needed.
Income Based Life Insurance Calculator: uses the value of an existing policy, and measures it against the user's current income needs.
Comprehensive Life Insurance Calculator: the most complex aid of this type, this calculator evaluates over 25 variables to determine just how much life insurance to buy.
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