Life insurance pays a “face amount” to the beneficiary of the policy upon the death of the insured person. The purpose of life insurance is to fund the needs of anyone who would suffer from the loss of your income resulting from your death. Life insurance is used to satisfy both business and personal needs.
- Collateral for business loans
- Funding for buy/sell agreements
- Funding lost profits while seeking a replacement for a key executive
- Providing benefits to key employees and general employees
- Funds to raise and educate children
- Funds to cover funeral expenses and unpaid medical bills
- Buffer to allow survivor time to adjust
- Funds to pay estate taxes and allow retention of certain non-liquid assets or a family owned business
- Funds to care for a disabled child or elderly parent
- Funds to provide for a charitable bequest
- Funds to liquidate a significant debt
Types of Life Insurance
- Term Insurance
- Variable term
- Level premium term
- Permanent Insurance
- Whole life
- Universal life
- Variable life
- Variable universal
Understanding the advantages and disadvantages of each type of policy and applying that information to your own personal situation is no easy task. It is a necessary task, however, since all too many insurance agents will push the product that suits their purpose rather than yours.
Term insurance provides a specified death benefit for a specified period of time. At the end of the term, which may be a set number of years or may be at a certain age, the policy will lapse. Variable term policies will change during the term of the policy, either decreasing the amount of coverage as the insured gets older, increasing the cost as the insured gets older, or both. Level premium term policies lock in the cost of the coverage for a specified number of years (typically ten to twenty) before the premiums can be increased or coverage reduced. Some term insurance policies can be converted to permanent insurance with no additional medical requirements and some policies can be automatically renewed upon the expiration of the original term.
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The primary advantage of term insurance is that the purchaser can get more coverage for less money than with permanent insurance. This makes term insurance especially attractive to young families with needs for housing, education and costs of raising a family. Term policies become less attractive with age because premiums for older persons can be very expensive. There is also no cash value build-up in a term insurance policy, so that the only benefit is the death benefit, which is only collected if the insured person dies while the policy is in force.
Permanent insurance continues to provide coverage for as long as you continue to pay premiums. The premiums are based on your age at the time the policy is purchased, and typically do not increase with age. Because the premiums do not increase with age, the cost of coverage is initially more expensive than term insurance. The cost of a typical policy is significantly more than term insurance because the policies accumulate cash value, which may be refundable upon surrender of the policy. While the policy is in place, the cash value can be used as a source for an inexpensive loan or it can be used to pay premiums.
Whole Life insurance has a fixed guaranteed interest rate and results in guaranteed cash values.
Universal Life insurance is an “interest driven” type of policy. There is a low guaranteed interest rate, but the policy is generally purchased with an expectation of higher returns. If returns are low on a continual basis, the policy may require supplements to the premiums. Universal life policies allow limited changes in the death benefit and the amount and frequency of premium payments.
Variable Life insurance has no guarantees on either interest rate or cash value, with perhaps a minimum guaranteed death benefit. The death benefit and the cash value fluctuate with the performance of an underlying portfolio of investments selected by the purchaser.
Variable Universal insurance combines the flexible premium and death benefit of a universal life policy with the investment flexibility and risk of a variable life policy.
Key Facts to Remember
Riders are available (at additional cost) to cover:
- Disability waiver of premium
- Guaranteed purchase options
- Coverage of spouse or children
- Double indemnity for accidental death
Some policies provide for and riders are available for others that:
- The proceeds can be accelerated and paid prior to death in the event of catastrophic or terminal illness or long-term care.
Life insurance proceeds on policies that you own will be subject to estate tax. Consider whether it makes more sense to have your beneficiary purchase the policies and gift them the funds to make the premium payments.
Consider naming a secondary beneficiary to receive the insurance proceeds in the event that your primary beneficiary is no longer living. If the proceeds go into your general estate, they will be subject to possible delays in probate.
The cash value of a policy can be used as a source of a loan at an interest rate stated in the policy.
The proceeds of a life insurance policy are generally exempt from income tax.
The cash value of a policy can be used to maintain the policy without further payment of premiums once the policy has accumulated sufficient cash value.