Life Insurance Protection for Your Family, Investments, and Estate
An important part of a financial planning strategy. Becoming financially secure and accumulating assets includes taking responsibility for your children, your mortgage, college expenses, savings, and debts. Whether you live or die, you and your partner/spouse are responsible for obligations you incur.
During your early family life when responsibilities are high, needs for insurance protection are also high. But as your children grow and you pay off your mortgage and other expenses, your responsibilities decrease and so do your needs for insurance. Your needs for life insurance protection will be reduced through savings, a reduction in your debt and other liabilities, index or whole life annuities with a guaranteed income, and other investments that accumulate cash.
Term Life Insurance and Permanent Life Insurance Investment Policies
There are many different types of life insurance. All policies are based on the Cost of Insurance (COI). Some provide your beneficiaries with a death benefit if you die within the term of the policy. Others include living benefits should you become seriously ill. Still other types of life insurance can be permanent (COI plus cash value), serving as a life insurance investment. These policies build in opportunities to save and take advantage of additional tax benefits.
Life insurance is easy to obtain and affordable when you are young – a time when your responsibilities are growing. Unfortunately many people wait until later in life when even a small amount of life insurance can be very expensive. Also, as people age, they are more likely to develop health problems which makes it difficult or impossible to qualify.
Life insurance provides a tax-free benefit. Upon the insured’s death, the full cash value of the policy is paid to the beneficiary tax-free. And when the cash value of the policy is sufficient, premiums paid into the policy may be taken as tax-free cash withdrawals or borrowed against as tax-free loans.
Common Motivations and Uses for Life Insurance
- Allows your family to survive your loss without being financially devastated.
- Can replace the monetary value of services provided by a stay-at-home parent.
- May be used to pay off a mortgage or other loan obligations.
- May be required for the key person and/or employee in a business.
- With sufficient cash value in a policy, may permit tax-free withdrawals.
- May be used as a strategy for tax-free savings.
- Permanent policies can be used as a life insurance investment.
- Can provide for accidental death benefits as a stand-alone insurance or added to an existing policy.
- Can provide living benefits known as Accelerated Death Benefits in the event of serious illness.
- Policies may be purchased for the payment of final expenses.
Common Life Insurance Questions
Whether you are a breadwinner, stay-at-home parent or single person living alone, there are many reasons why you need life insurance. Obviously if were to pass away and provide the primary financial support for your family, it would have devastating consequences. But even the stay-at-home parent provides many services that would be costly to replace. Think of what it would cost to hire people to cook, clean, babysit, help kids with homework, and more. According to Salary.com, the value of a stay-at-home parent is over $112,000 per year.
Then there’s the single person who might have several reasons to obtain life insurance. It could be for the support of parents or siblings. It might be used to pay off debt from a mortgage or other loan. They may want to purchase insurance at a low cost while they are young and healthy. The insurance may be to protect business interests or to take advantage of a policy that provides tax benefits and savings.
Whether you qualify for life insurance will depend on your age, health status and risk factors that make it likely that you will survive the policy term. Men will always pay more as they are statistically more at risk for dying earlier than women. Many life insurance policies require a medical history, physical and laboratory testing to determine whether you are a good risk for them. Young, healthy people are more likely to be approved and to pay the lowest rates.
The amount of life insurance you need will depend upon your stage of life and responsibilities for children, mortgage, college, savings, and debts. If you your responsibilities are high, the formula 10/20 tool is a good calculation tool used by leading financial professionals. With formula 20/10, 20 relates to savings by retirement and 10 pertains to life insurance. Accordingly, you will need 20 times your annual income in savings by retirement and 10 times your annual income is the amount needed in life insurance. As an example, if your income is $50,000 per year, your insurance needs would be $500,000. Of course, as your savings increase and debt decreases, your needs for life insurance will be proportionately reduced.
Term life insurance provides a specific amount of coverage for a set period of time. As with other life insurance, rates and qualifications are based on age, gender, and health status. Term insurance can be renewable or nonrenewable. Renewable guarantees that the insurance will be renewed for the life of your policy regardless of your health. With nonrenewable term, renewal may be declined based on health.
Term life insurance can be purchased as an annual renewal, level term, and return of premium term. Annual renewable terms renews annually at a higher price. This type of insurance is inexpensive when you are young but becomes very expensive when you are old. Level term for 5, 10, 20 and 30 years provides coverage at the same annual rate for a level period of time. The cost of the policy is more for higher fixed term periods as your risk of dying increases with age. Return of Premium Term refunds the premium paid if the insured survives the term of the policy. Although this may seem attractive, the costs of this type of policy are higher and it may have adverse tax implications.
Whole life is a type of permanent life insurance that provides a cash value, serving as a life insurance investment. Besides paying for the cost of insurance (COI), with whole life you pay higher premiums. The difference between COI and the premium paid provides a cash value that earns a guaranteed rate of interest. The cash value builds up in early years and continues to grow. If the cash value is large enough, it will guarantee payment of the death benefit plus the cash value for your entire lifetime. Once you qualify and provided you pay the required premiums, the policy will remain in effect. The premium will not increase because of your age or health status.
The disadvantage to whole life is its inflexibility. Although the premium and death rate are fixed and the amount of interest guaranteed, the time to accumulate cash is very slow. You have no options to change the death benefit. If you miss any premium payments, the policy can lapse. There also can be surrender charges if the policy is cancelled in the early years.
Universal life is a type of permanent life insurance that provides a cash value and serves as a life insurance investment. Unlike whole life, it offers flexibility for premiums, death benefit, and interest paid on cash value. Universal life allows you to change your premium and even skip payments provided the cash value of the policy is adequate. With universal life, you can also adjust your death benefit to fit with life-changing conditions. And instead of a fixed rate of interest as in whole life, universal life can provide interest growth based on market conditions. This means the interest can be adjusted up or down. Some policies provide a guaranteed minimum interest payment.
Index Universal Life (IUL) is a type of permanent life insurance in which its cash value is tied to a certain index, such as the S&P 500. The rate of interest paid, therefore is based on the performance of the index with a ceiling maximum called a cap. Should the index drop however, there is a minimum floor which means your cash within the policy may not grow but will not lose any of its value in a down market. Should the index gain 15%, you will get a 13% return as the maximum cap amount. Like other types of permanent policies, IUL serves as a life insurance investment.
Although the main purpose of life insurance is to protect your family, business, or estate when you die, the insured may have critical needs for income during their lifetime. Living benefits, also called Accelerated Death Benefits, pays you a portion of the policy’s death benefit in the event of serious illness. This can be included in both term and permanent life insurance policies.
All life insurance provides a tax-free benefit to beneficiaries that includes payment of the death benefit and all accumulated cash value tax free. When sufficient cash value is present, the insured can also receive tax-free withdrawals up to the cost basis of the policy. Tax-free loans are also allowable where you can receive more money than you paid in premiums. In this case you are charged a low cost interest rate on the loan which is offset by the interest earned and makes the net interest rate extremely low.
When it comes to buying life insurance, you should buy the type of policy that is suitable and affordable for you. This should be based on your calculated insurance needs, your age and health status, your budget, your financial obligations, and other options you have to build up cash that fit with your savings and investment goals.
Permanent insurance is best suited for people who are young, healthy and have a long period of time to accumulate cash value. All permanent insurance, whether it is Whole Life (WL), Universal Life (UL), or Index Universal Life (IUL), includes a term portion for Cost of Insurance (COI) which always increases in cost based on age. The longer you have the policy, the higher the COI and the lower the cash value. Should your health decline however, it will not affect your policy premiums or coverage.
If you want permanent insurance to cover you for your entire lifetime, you must have enough money in the cash value to pay for the COI. Should your cash value be too small, permanent life insurance gives you the option to reduce your death benefit to extend coverage for your lifetime.