Life insurance is simply protection to ensure that your family will have financial security when you pass away. If something should happen to you, how will they be able to continue doing the things they take for granted, such as live in a nice home, continue their education, or create a retirement nest egg without you? Life insurance can help to provide the answer. In this section, we’ll help you begin to think about Life insurance. We’ll take a look at the two basic types of Life insurance, how to achieve an appropriate level of Life insurance, how to read your policy, and how to address typical planning concerns. All designed to provide you with a framework for considering how much life insurance you need.
There are many reasons for purchasing life insurance:
- Family protection to provide financial security to surviving family members on the death of the insured person.
- To pay for children’s education.
- Insurance to cover a particular need such as paying off a mortgage or consumer 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.
- To provide funds to pay estate taxes or other final obligations necessary to settle a deceased person’s estate.
- To provide the funds necessary for the deceased person’s burial expenses.
- Accumulation of funds to supplement retirement income.
Understanding The Basics
What is life insurance?
Life insurance is an agreement between you (the insured) and an insurance company (the insurer). Under the terms of a life insurance contract, the insurer promises to pay a certain sum to someone (a beneficiary) when you die, in exchange for your premium payments.
Why would you need life insurance?
The most common reason for buying life insurance is to replace the income lost when you die. For example, say that you work, and your income is used to support yourself and your family. When you die, and your paychecks stop, the life insurance proceeds can be used to continue to support the family members you’ve left behind.
Another common use of life insurance proceeds is to pay off any debts you leave behind. For example, mortgages, car loans, medical bills, and credit card debts are often left unpaid when someone dies. These obligations must be paid from the assets left behind. This can deplete the resources that your family needs. Life insurance can be used to pay off these debts, leaving your other assets intact for your family to use.
Life insurance provides liquidity to your estate. When you die, you may leave some liquid assets (such as cash, CDs, and savings bonds), and some illiquid assets (such as real estate, an automobile, and stocks). Your liquid assets may not be enough to pay all the debts that you leave behind, plus all the expenses that arise because of your death (such as funeral expenses and estate taxes). Your illiquid assets may have to be sold in order to meet these obligations when they come due. This may cause a financial loss if the assets must be sold cheaply in order to get the money on time. Life insurance can avert this situation, because the proceeds are available almost immediately upon your death.
Life insurance creates an estate for your heirs. After your debts and expenses are paid, there may not be much left over for your family. Life insurance can automatically provide assets for them after your death. Life insurance is also a great way to give to charity when you die. You may have always had a great philanthropic desire, but not the means to make it a reality. Life insurance can do that for you.
Life insurance can even be a key element for specialized business applications, such as funding a buy-sell agreement. Under a buy-sell agreement, life insurance can be used to provide cash for the purchase of a deceased owner’s interest in the business. Finally, life insurance can be an investment vehicle. Some types of life insurance policies may actually make money for you, as well as provide the benefits described above. This can help you with long-term financial goals and strategies. What do you need to know about life insurance?
There are several kinds of policies that may be available to you. Term life insurance policies provide life insurance protection for a specific period of time or term. If you die during the coverage period, the beneficiary named in your policy receives the policy death benefit. If you don’t die during the term, your beneficiary receives nothing. Common term policies last for 10, 15, 20 and even 30 years. Permanent insurance policies provide insurance protection for your entire life as long as the policy remains in force. In addition to the insurance protection provided, this type of policy also builds internal cash values, often described as a savings account within the policy.
The different kinds of permanent insurance policies:
- Whole life
- Ordinary level premium whole life
- Limited-pay whole life
- Current assumption whole life
- Adjustable life
- Universal life
- Joint life (first to die)
- Survivorship (second to die)
You also need to know that the cost of life insurance will depend upon the type of policy, your age, and your health at the point in time when the policy is issued.
A life insurance contract is made up of provisions, options, and riders. Provisions describe or explain features, benefits, conditions, or requirements of the contract. Options are features of the agreement that require you to make a choice regarding some aspect of coverage. Riders are additional coverage (or endorsements) offered by the insurer at the time of application and added to the standard agreement in return for an additional premium. Finally, you need to know the tax consequences of owning life insurance.
- Life insurance premium payments are not tax-deductible expenses.
- In general, the death benefit paid to the beneficiary is not included in gross income for federal income tax purposes, because it is paid with after-tax dollars.
- You must be very careful about who owns the policy and who the beneficiaries are, in order to avoid estate taxes on the proceeds when you die.
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