Life insurance is one of the pillars of personal finance.
Demystifying the Life Insurance Puzzle
The complexity of life insurance can be demystified by arming yourself with the proper information. You can simplify the decision-making process and arrive at the right choice for you and your family.
10 things you absolutely need to know about life insurance:
1. You Need to Buy Insurance If...
- Anyone relies on you financially,
- You are a spouse or the parent of dependent children.
- You are ex-spouse, life partner, a child of dependent parents, the sibling of a dependent adult,
- You are an employee, an employer or a business partner.
*Retired or financially independent with no one financially dependent on you then maybe you don’t need life insurance. However, you may want to consider using life insurance as a vehicle pass on to your financial assets to heirs.
2. Compensation for the inevitable financial consequences that accompany the loss of life.
- Covering the costs of final expenses, outstanding debts and mortgages, planned educational expenses and lost income
3. A policy is a contract
- Between a life insurance company and a person (a trust) who has a financial interest in the life and livelihood of an individual.
- Insurance companies pools the premiums from policyholders and pays out claims—called a death benefit—in the event of a death.
- The difference between the premiums taken in and the claims paid out is the insurance company’s profit.
4. The four primary roles, in a life insurance policy.
- The insurer is the insurance company, responsible for paying out claims in the case of a death
- The owner of the policy is responsible for premium payments to the insurance company.
- The insured is the person upon whose life the policy is based
- The beneficiary is the person, trust or other entity due to receive the life insurance claim—or death benefit—in the case of the insured’s passing
5. A risk management tool. Not an investment.
- Some policies have an investment feature and tax privilege, but insurance is rarely an optimal investment vehicle.
- life insurance that contain an investment component is covered in #7
6. Term or Permanent are the two broad varieties of life insurance.
- Term life is the most widely applicable, least expensive and the simplest form of insurance.
- Policy premiums are based on the probability that the insured will die within a stated term—typically 10, 20 or 30 years
- Premiums are guaranteed for the length of the term
- Includes this same probability-of-death calculus, but also includes a savings mechanism.
- “cash value,” is designed to help the policy exist into perpetuity
- Whole life—the original—has an investment component much like bonds or CDs
- Variable life offers investment options like mutual funds.
- Universal life a less expensive permanent life insurance alternative with added flexibility, but increased interest rate risk for owners
- For a small number of people business planning and/or high-net-worth estate planning—permanent life insurance may be engineered to maximize the tax-privileged growth of cash value.
7. Expensive or Surprisingly Inexpensive
- Term/Permanent comparisons are not apples-to-apples.
- Compared to Term a individual might be required to pay 10—or even 20—times more for variable or whole life insurance policy with the same death benefit
- Smoker pay twice as much for any of the above.
- Health problems could triple or more the cost or simply be declined coverage
8. Determining the optimal life insurance policy
- Buy enough life insurance to replicate all or most of the insured’s income for a term as long as the household expects to need that income.
- Multiply a wage earner’s income by 15 and purchase a policy with an equivalent death benefit for a term that extends until the person insured would retire.
- 75% of a wage earner’s income if the death benefit was conservatively invested to earn 5%
9. Online vs A Live Person
- A live person can walk you through the application and underwriting process.
- Insurance premiums from a companies are identical whether you apply online, via a toll-free number or with a person.
- Underwriting - Insurance companies way to classify how much of a risk you are, based on your current health, past health, the health of your parents and siblings
10. Before canceling your Policy
- Know your options
- Health complication could lead to you being declined for a new policy
- unnecessary permanent policy with a cash value analyzing its present and expected future investment value, as well as any prospective tax complications,