Life insurance may not be a huge priority for you right now but knowing what it is and who needs it is still important. Term life may be a good option for some while permanent life insurance could be better in particular scenarios.
What is Life Insurance?
Life insurance is a contract between a policyholder and an insurer where the insurer guarantees a payout to named beneficiaries following the death of the policy holder. The policy holder makes premium payments, and the life insurance provider pays a lump-sum amount (aka death benefit) to the beneficiaries when the policy holder dies.
People have different reasons for buying a life insurance policy but usually it is to protect their love ones financially in the case of their death. Let’s take a look at some of the reasons people purchase a life insurance policy.
Who Needs a Life Insurance Policy?
Life insurance is a financial safety net to assist beneficiaries or surviving dependents following the death of the insured policy holder. Here is a look at who needs life insurance:
- Parents with Young Children: when an income earning parent dies, the rest of the family can be left with financial hardship considering the lost household income. Life insurance can help pay the bills and keep the insured family afloat financially following a death.
- Parents with Disabled Children: special-needs children or disabled adult children who will never be self-sufficient and who will always need care will benefit greatly from a life insurance policy. Full time care is awfully expensive and the death benefit from a life insurance policy can be used to pay these ongoing costs.
- Older Parents Who Desire to Leave Children Money: more than ever people are caring for elderly parents (often at their own time and expense). A life insurance policy here can help a child recoup some of the income lost by caring for their elderly parents following the parents death.
- Property Owning Adults: If a couple (married or not) will not be able to afford the monthly mortgage payment following the death of one of them, a life insurance policy can help the living member afford the loan, taxes, and upkeep costs for the property.
- Wealthy Families Expecting to Owe Estate Tax: Life insurance can provide cash to cover estate taxes, so the inheritor receives the full value of the estate.
- Families Who Cannot Pay for a Funeral or Other Burial Expenses: a small life insurance policy can cover the costs of a funeral, cremation, or other burial variety. Families who cannot pay upwards of $10,000 out of pocket for a funeral should consider a small life insurance policy to cover burial expenses.
- Young Adults Looking to Secure a Low Rate: healthy younger individuals will pay lower insurance premiums for life insurance. This means that 20-something adults can purchase a policy (even with no dependents) with the expectation they will have dependents in the future. By signing up for a policy so young they have a low insurance rate which they can lock in for a long period of time.
- Pensioners (Married): some pensions do not have spousal benefits meaning if the pensioner dies their spouse gets little or nothing, while others do but you get less money up front in the idea that if you die your spouse gets the pension benefit. The pensioner can opt to receive their entire pension (not using the spousal benefit if there is one) and use the full pension to pay for a separate life insurance policy. It’s a smart way to get the full pension payment and still have a life insurance policy for the non-pensioned spouse.
- Certain Businesses: in some companies the death of a key employee (like a CEO) can put serious financial strain on the remining people at the organization. The organization may have an “insurable interest” and can put a life insurance policy on that key employee (like the important CEO) to protect the organization in the death of that employee.
As you can see there are lots of reasons why people purchase a life insurance policy. There are also more than the 9 reasons listed here and you should speak with an insurance specialist to find out if you should be looking at life insurance.
How Does Life Insurance Work?
There are two main pieces to a life insurance policy, the monthly premium (pay-in) and the death benefit (payout). Let’s take a look at each aspect.
Note: whole life or permanent life insurance policies have a cash value component as well.
- Premiums: this is the money that the policyholder pays to the insurer for the insurance coverage. Following the death of the insured the insurer pays the “death benefit” out to the beneficiaries on the account. Premiums for life insurance are determined a few keyways and the costs will vary based on age, activity level, overall health, family medical history, and more. The premium will reflect what the insurer determines is the policyholders life expectancy. A portion of the premium will also go to the operating expenses of the insurance company. The amount of the death benefit will also affect the premium costs (the higher the death benefit payout, the greater the individuals risk of death, and policies that accumulate a monetary value will have higher premiums).
- Death Benefit (face value): this is the amount of money that the insurer guarantees to payout to beneficiaries following the death of the policy holder. The insured individual chooses the amount of the death benefit they want based on the financial needs of the beneficiaries. The insurance company will make a determination based on multiple factors if the insured qualifies for a death benefit of that size (aka. Insurable interest).
- Cash Value: permanent life insurance policies also function as a savings account the policyholder can use for the length of their life. The value grows on a “tax-deferred” basis which is an added benefit. The insured can use the cash value of the life insurance policy to pay the monthly premiums or get more insurance. The cash value can also be used as collateral for a loan or other expenses. When the insured dies the cash value becomes the insurance companies, it does not go to a beneficiary.
These are the three main components of life insurance policies.
Types of Life Insurance Policies
There are several different types of life insurance policies, let’s take a look.
- Term Life Insurance: A term life insurance policy provides financial protection for a specific length of time, like 10 or 30 years. The premium payment will not change over the course of the set time period for a traditional term insurance policy. After the term length insurance companies may offer you to continue your coverage but at a higher premium rate. This option is usually less expensive in comparison to permanent life insurance.
- Permanent Life Insurance: This variety of life insurance policy covers the insured for the entire length of their life (as long as they continue to pay premiums). It is usually more costly than a term life insurance policy because it covers the entire length of the insureds life.
- Whole Life Insurance: This policy variety is similar to a permanent life insurance policy except with whole life insurance the policy accumulates a cash value.
- Universal Life: similar to a whole life policy except the cash value accumulates interest over time and also the premiums are more comparable to a term life insurance policy. Premiums and death benefit can change over time.
- Guaranteed Universal: builds no cash value and usually has lower premiums in comparison to a whole life policy.
- Indexed Universal: a variety of universal life policy which allows policyholders to earn equity-indexed or fixed rate of return on it’s cash value.
- Variable Universal: this variety allows the policyholder to take the cash value of the policy and invest it.
- Guaranteed Issue: a variety of permanent life for individuals with medical conditions which make other life insurance policies nearly impossible to qualify for. Guaranteed issue does not pay a death benefit within the first 2 years of the policy following mortality from the medical issues in question but will pay out following accidental death. If the policy holder dies within the 2-year period, the beneficiaries do get their money back from premiums that were paid in plus interest.
- Final Expense (Burial): a permanent policy with a small death benefit to cover funeral and burial expenses (though the money can be used in anyway the beneficiary chooses).
How Much Life Insurance Should You Buy?
You should take a look at your financial circumstances and determine what sort of money would be needed to sustain your beneficiaries current lifestyle and standards of living. If you are the main breadwinner and have young children (under the age of 5), you want to have enough insurance coverage to get them to an age they will old enough to support themselves.
What would a nanny cost? What about rent and insurance? Room and board? What about money set aside for their education?
You should look at your beneficiaries and what it would cost to get them to a point where they can keep things going on their own. If your spouse never worked and you have small children, this means you’ll likely need a suitable life insurance death benefit (as long as you can afford it) to cover their living costs.
You want to protect your family in the event of your death and having enough life insurance to do that will vary person to person.
How Do I Qualify for Life Insurance?
Life insurance companies evaluate every application on an individual basis. Because there are hundreds of places to purchase life insurance, nearly every person (in any condition or age), can find a policy somewhere. There are almost 1000 life insurance companies here in the United States, that means you have some options when shopping for life insurance quotes.
These companies also sell different varieties of life insurance policies and some specialize in specific policies for specific people. Then there are brokers who work with individuals to find the right coverage for their particular needs. So, anyone can find life insurance if they look.
How you qualify for life insurance will depend on various factors. Insurers will look at your age, sex, medical history, activity level, job description, family medical history, and more. What they look at will be based on the type of life insurance you are applying for. As a general rule, the younger you are and the healthier, the less you’ll pay for a life insurance policy. The older you are and if you engage in risky lifestyle choices (like cigarette smoking), it may be harder to qualify for certain policies or levels of coverage.
Always be honest when filling out an application. You wouldn’t want to say you don’t smoke and then run into complications down the road because you had illness due to smoking and the insurance company cancelled your policy. The more honest you are the safer your policy will be should your beneficiaries need to file a claim.
Verdict: Life Insurance is Smart for Most
Life insurance is something that can really help your loved one’s in the unfortunate case of your death. As we’ve seen from above some people will have a greater need with a life insurance policy. Young unmarried individuals may have little need now but can benefit down the road by getting a policy while young and healthy. No matter which way you look at it, life insurance is a smart safety net for most people and is something you should be considering. Remember to shop around and get multiple quotes to get the best deal for the longest time frames.