Life Insurance Can Be Your Safety Net

Table of Contents

Bad things happen to all of us. You can’t control everything. We can, however, control how we respond to unfortunate situations. We can also reduce the adverse effects of certain events by providing a safety net. Life insurance can be a safety net.

A life insurance policy is a contract with an insurance company. You, the insured, or your representatives, pay premiums to an insurance company. In return, the insurance company makes a lump-sum payment, known as a death benefit, to beneficiaries in the event of your death. The owner typically chooses life insurance based upon both her needs and goals. Death benefits from all types of life insurance are generally federal income tax-free.

Reasons to purchase life insurance

Life insurance may be purchased:

To pay off debt. This may include paying your mortgage so your family does not have to move if you were to pass away.
To replace your spouse’s income. Replacing the income of a working spouse may allow you and your family to maintain the same standard of living. The death benefit may enable you to afford child care.
To provide for your children. This may allow your children to have a college education or provide the funds to pay for their weddings.
As an alternative to electing the joint and survivor option for your pension plan. Instead, you can elect the single life option and obtain an adequate amount of life insurance on the single life. When invested, the life insurance proceeds could result in approximately the same benefit your spouse would have received from your pension plan.
To pay your estate taxes. This may allow the beneficiaries of your estate to pay the estate tax without selling inherited or other assets.
To pay burial costs and other final expenses.

Certain items identified above would have a fixed date when the need for life insurance benefits would no longer exist. For example, your mortgage will be paid off in 20 years and your children will be through college. On the other hand, paying your estate tax takes place upon your death, a date that is unknown.

There are various types of life insurance and their general characteristics are outlined below.

Term life insurance

The simplest form of insurance.
Level term insurance is the purchase of coverage for a specific price for a specified period. The premium stays the same for a specific multi-year period, usually 10, 15, 20, 25, or 30 years. For example, if you die it could be replacement income to pay for your children’s education or pay off your mortgage.
You can purchase annual renewable term year-by-year. With annual renewable term you may have to re-qualify by showing evidence of good health each year. The death benefit usually remains the same during the term, but the premium may increase each year.
Convertible term typically can be exchanged for a whole-life policy without evidence of insurability.
If you die during the policy period, your beneficiary receives the value of the policy.
There is no investment component to term life insurance.
If you want to extend the insurance after the term is complete, you may need to show proof of insurability again. At that time you may be denied coverage or may have to pay a significantly higher premium.
Term insurance is typically far less expensive than whole life, universal life, and variable life.

Whole life insurance

You may consider this type of insurance to be permanent. For example, if you expect to have a taxable estate, the death benefit could pay for the taxes.
Similar to term, but you purchase the policy to cover your “whole life,” not just a set period.
The policy combines life coverage with an investment fund.
Premiums remain level throughout the life of the policy, and the insurance company invests at least a portion of your premiums.
Cash value builds and is tax-deferred each year that you keep the policy.
You can borrow against the policy’s cash accumulation fund without being taxed.
Typically you cannot increase or decrease the death benefit on this type of policy.
This type of life insurance is usually more expensive than term insurance, but cheaper than variable life insurance.

Universal life insurance

This type of insurance may be considered permanent insurance.
The policy combines a life portion with an investment fund.

The life insurance portion of the premium must be paid but the additional amount used for the investment component is more flexible and may not have to be paid annually.
The excess of premium payments above the current cost of insurance are credited to the cash value of the policy.
Interest credited to the account is determined by the insurer, but usually has a contractual minimum rate.
The policyholder may be able to choose what investments the investment portion of the premium is invested in.
Once you have an accumulated balance in the investment portion of the policy, you can choose to have the investment portion pay the premiums.
You may be able to increase or decrease the amount of the benefit over time.

Variable universal life insurance

The premiums for a variable life policy can vary from nothing in a given month up to maximums defined by the Internal Revenue Code for life insurance.

With a variable life policy, there is usually a wider selection of investment products, including stock funds.
As with a universal policy, returns on investments can offset the cost of premiums or build in the account.
Depending on the type of policy, the beneficiaries will either receive the face value of the policy or the face value plus all or part of the cash account.
This type of insurance policy is generally the most expensive because of the flexibility given to investing.

If you choose to purchase life insurance, you should discuss the various types of insurance with your insurance agent, your financial planner or your trusted advisor. There maybe other variations of life insurance available such as: decreasing term, endowment insurance, survivor life or single premium whole life. Find the product that fits your needs and goals. However, you should read the policy terms very carefully.

How I Use Life Insurance

I didn’t have any life insurance until I had children. At that time I became concerned about what would happen to my family should I pass away. Therefore, I purchased mortgage insurance, insurance to cover college costs and insurance to pay for child care. I cancelled the term insurance policies once they were no longer needed.

The other need for life insurance arose at the time of my retirement. I had earned a pension from a retirement plan that required me to make a choice between two options: single retirement or joint and survivor. For me, it was cheaper to take the single retirement option, and buy term life insurance on my life to provide my wife a large enough lump sum benefit to provide adequate cash flow in the event of my death.

In all cases, I used term life insurance. I believe in keeping my insurance purchases and my investing separate. Therefore, rather than paying a larger premium to the insurance company, a portion of which would be invested, I purchased term insurance and do my own investing.

Why did you buy life insurance? What form of life insurance did you purchase?

Boomerbaggage Resources