Life Insurance Basics
Many financial experts consider life insurance to be the cornerstone of sound
financial planning. It can be an important tool in the following situations:
- Replace Income for Dependents
If people depend on an individual’s income, life insurance can replace that
income if the person dies. The most common example of this is parents with
young children. Insurance to replace income can be especially useful if the
government- or employer-sponsored benefits of the surviving spouse or
domestic partner will be reduced after he or she dies. - Pay Final Expenses
Life insurance can pay funeral and burial costs, probate and other estate administration costs, debts and medical expenses not covered by health insurance. - Create an Inheritance for Heirs
Even those with no other assets to pass on, can create an inheritance by buying
a life insurance policy and naming their heirs as beneficiaries. - Pay Federal “Death” Taxes and State “Death” Taxes
Life insurance benefits can pay for estate taxes so that heirs will not have to liquidate other assets or take a smaller inheritance. Changes in the federal “death”
tax rules through January 1, 2011 will likely lessen the impact of this tax on
some people, but some states are offsetting those federal decreases with increases in their state-level estate taxes. - Make Significant Charitable Contributions
By making a charity the beneficiary of their life insurance policies, individuals
can make a much larger contribution than if they donated the cash equivalent
of the policy’s premiums. - Create a Source of Savings
Some types of life insurance create a cash value that, if not paid out as a death
benefit, can be borrowed or withdrawn on the owner’s request. Since most
people make paying their life insurance policy premiums a high priority, buying
a cash-value type policy can create a kind of “forced” savings plan. Furthermore,
the interest credited is tax deferred (and tax exempt if the money is paid as a
death claim).
Insurance Basics
Life Insurance
Types of Life Insurance
There are two major types of life insurance: term and whole life. - Term Life
Term insurance is the simplest form of life insurance. It pays only if death
occurs during the term of the policy, which is usually from one to 30 years.
Most term policies have no other benefit provisions. There are two basic types
of term life insurance policies: level term and decreasing term. Level term means
that the death benefit stays the same throughout the duration of the policy.
Decreasing term means that the death benefit drops, usually in one-year increments, over the course of the policy’s term. - Whole Life/Permanent Life
Whole life or permanent insurance pays a death benefit whenever the policyholder dies. There are three major types of whole life or permanent life insurance—traditional whole life, universal life, and variable universal life, and there
are variations within each type.
In the case of traditional whole life, both the death benefit and the premium are designed to stay the same (level) throughout the life of the policy. The
cost per $1,000 of benefit increases as the insured person ages, and it obviously
gets very high when the insured lives to 80 and beyond. The insurance company keeps the premium level by charging a premium that, in the early years, is
higher than what is needed to pay claims, investing that money, and then using
it to supplement the level premium to help pay the cost of life insurance for
older people.
By law, when these “overpayments” reach a certain amount, they must be
available to the policyholder as a cash value if he or she decides not to continue
with the original plan. The cash value is an alternative, not an additional, benefit under the policy. In the 1970s and 1980s, life insurance companies introduced two variations on the traditional whole life product: universal life insurance and variable universal life insurance.
Some varieties of whole life/permanent life insurance are discussed below.
• Universal Life: Universal life, also known as adjustable life, allows more
flexibility than traditional whole life policies. The savings vehicle (called a
cash value account) generally earns a money market rate of interest. After
money has accumulated in the account, the policyholder will also have the
option of altering premium payments—providing there is enough money in
the account to cover the costs.
Life Insurance
Insurance Basics
• Variable Life: Variable life policies combine death protection with a
savings account that can be invested in stocks, bonds and money market
mutual funds. The value of the policy may grow more quickly, but involves
more risk. If investments do not perform well, the cash value and death
benefit may decrease. Some policies, however, guarantee that the death
benefit will not fall below a minimum level.
• Variable Universal Life: This type of policy combines the features of
variable and universal life policies, including the investment risks and
rewards characteristic of variable life insurance and the ability to adjust
premiums and the death benefit that is characteristic of universal life
insurance.
