Defining Your Needs
The purchase of life insurance is an important decision for both you and your family. There are many reasons why life insurance policies or annuity contracts are purchased, but these reasons should be based upon your financial planning needs. Factors such as your marital status, number of dependents and cost for their support, future education needs, current and anticipated family income, and your current assets and debt obligations all play a role in determining the amount of life insurance that is right for you.
Choosing the Amount of Life Insurance
Your need for life insurance will vary with your age and responsibilities. The amount of insurance you buy should depend on the standard of living you wish to assure for your dependents. You should consider the amount of assets and sources of continuing income available to your dependents when you pass away. Simply stated, you should choose an amount of life insurance that is determined necessary to meet the needs you are trying to satisfy. A balance needs to be achieved in this process. To be over-insured can negatively affect your budget and threaten your long range financial goals just as much as being under-insured can. While each person must individually assess their responsibilities, needs, and financial situation, it is important to be careful to choose an amount of life insurance that reflects your specific circumstances without under-insuring or over-insuring.
Steps To Determine How Much Life Insurance You Need:
- Determine how much life insurance you need based on the factors mentioned above.
- Decide how much money you can afford to pay.
- Choose the type of life insurance policy that meets your coverage goals and current family budget. Fitting these two factors together will move you toward a successful overall financial plan.
Once you have completed these steps, you will be able to move ahead and contact several life insurance companies (through an agent or broker) to shop for the right type of policy for you.
There are many reasons for purchasing life insurance, among which are the following:
- Insurance to provide financial protection and security for surviving family members upon the death of the insured person.
- Insurance to cover a particular need such as paying off a mortgage or other debt upon the insured's death.
- Business insurance to compensate a company on the death of a key employee or to provide a surviving partner the resources to buy out the deceased partner's share of the business.
- Insurance to provide funds to pay estate taxes or other final obligations necessary to settle a deceased person's estate.
- Insurance to provide the funds necessary for the deceased person's burial expenses.
Choosing the Appropriate Type of Life Insurance
There are two basic types of life insurance: term life insurance and cash value life insurance. There are many policy variations between these two types of life insurance.
We recommend guaranteed level term life insurance coverage to most families. Guaranteed level term life insurance provides pure protection for a level amount of coverage at a premium amount that remains level for a specified period or term (ie. 15 years, 20 years, 30 years). This coverage provides the most coverage for the least cost.
The Theory of Decreasing Responsibility applies to many of our clients. This theory states that in the earlier years clients have many responsibilities to be protected such as young children, debt, and mortgages with less money to spend for proper protection. Later in life (20 - 30 years) after the children are grown, mortgage is paid, and with less debt there is less need for protection and more money available to provide for coverage to the extent it is still needed. Level term life insurance provides the most coverage for the least amount of premium to allow for maximum protection.
Ultimately you must decide the best coverage and protection to suit your specific situation. We are here to guide you through the process.
Term Policies provide life insurance for a specified period of time. This period could be as short as one year or provide coverage for a specific number of years such as 5, 10, 20 years or to a specified age. If you die during the term period, the company will pay the face value to your beneficiary. If you live beyond the term period you had selected, no benefit is payable. As a rule, term policies offer a death benefit with no savings element or cash value. If you have a limited amount to spend, and only need insurance for a specified period of time, you may be able to get more coverage by buying term insurance than by buying cash value insurance. When you buy term insurance, you need to make a choice as to how long you want the protection. You may renew the policy without a physical examination for the period of years specified in the policy. Some term insurance can be converted to cash value insurance up to a specified age with no physical examination. Premiums for the converted insurance will most likely be higher than the premiums you would be paying for the term insurance. If you do not pay the premium for your term insurance, it will generally lapse without cash value.
Cash Value Insurance combines death benefits with a cash value accumulation feature. The buyer of a cash value policy pays more in the early years than for term insurance, but the premium not needed to pay for the cost of the death benefit accumulates with interest within the policy. If the policy is surrendered before the insured person dies, there may be a cash value paid to the owner, less any outstanding loans placed against the policy.
Make sure the agent/broker provides you with the method by which the cash value is determined and that they obtain this information based on the policy's guaranteed value. It is not a good idea to buy a cash value life insurance policy if you plan to surrender early due to substantial surrender penalties. If all premiums are paid, cash value insurance usually lasts for the entire life of a person and pays death benefits to the beneficiaries named in the policy upon the death of the insured. The cash value can be used as loan collateral for borrowing funds at the interest rate specified in the policy. Any outstanding loans are deducted from policy proceeds at death or at policy surrender.
Some of these products may enjoy tax advantages while they remain active. Therefore, a policy lapse or surrender may create a taxable event and may generate a Form 1099. Form 1099s are sent to the IRS for tax purposes; be sure to check with your tax advisor. Some of the most popular types of cash value insurance are described below:
Whole Life Insurance (also known as straight life, ordinary life, and traditional permanent insurance) is designed to provide coverage for your entire lifetime unlike term insurance which provides protection for a specified time period. To keep the premium level, the premium at the younger ages exceed the actual cost of protection. This extra premium builds a reserve (cash value) which helps pay for the policy in later years as the cost of protection rises above the premium. Whole life policies stretch the cost of insurance over a longer period of time in order to level out the otherwise increasing cost of insurance. Under some policies, premiums are required to be paid for a set number of years. Under other policies, premiums are paid throughout the policyholder's lifetime.
Universal Life Insurance is the most flexible of all the various kinds of policies because it treats the elements of the policy separately; universal life allows you to change or skip premium payments or change the death benefit more easily than any other policy. It works by treating the three elements of the policy, premium, death benefit and cash value separately. Cash values are accumulated by crediting premium payments and interest to a fund from which deductions are made for expenses and cost of insurance. Interest rates are linked to an external index such as Treasury bills. Because the cash value element of this type of policy is interest rate sensitive, predictions of future Life costs are highly dependent upon the accuracy of interest rate projections. The policy can also be structured to operate like term insurance.
Variable Life Insurance has a death benefit that varies in relation to the investment experience of the assets underlying the policy. A higher rate of return on the invested fund will cause the death benefits to increase, while a low or negative rate will cause the death benefits to decrease.
Variable Universal Life Insurance combines the flexibility of universal life insurance with the investment account features of variable life insurance.