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How to Buy Life Insurance
Life insurance is primarily a product for families. If you
have a spouse and children who depend on your income and you
don't have extensive resources, then life insurance is a useful
tool to help them pay expenses. Single people without dependents
typically don't need the same amount of life insurance because
they don't have as many responsibilities that will outlive them.
Most financial planners would tell you that insurance is not
a replacement for a long-term savings or investing strategy but
an additional cushion. Depending on your financial situation,
life insurance and its ancillary products can have some very
attractive tax characteristics as well.
Who needs life insurance? Those with dependents,
either children or friends or family members with special needs;
with a nonworking spouse or one with an income substantially
lower than yours or those with a big mortgage that will be too
overwhelming for one income to pay off.
How much is necessary? Optimally, the right amount of
life insurance allows your survivors to invest the insurance
payout and then draw down the account over time in a way that
matches the income you would provide if you were still around.
You need to figure far more than a family's basic living
expenses adjusted for inflation. Also consider:
- Education funds needed for
each child from grade school to college.
- Money to cover special health
expenses for a family member already diagnosed at the time
of the insured's death.
- Funds for child care if the
surviving spouse needs to keep working.
- Emergency funds that your
survivors can keep in reserve.
Types of life insurance. There are six basic types of
life insurance:
- Term. Term life
insurance is the simplest kind of life insurance because it
pays if death occurs during the term of the policy, which is
usually from one to 30 years. There are two kinds of term
life insurance: Level term means that the death
benefit stays throughout the duration of the policy, and decreasing
term means that the death benefit drops in one-year
increments over the duration of the policy.
- Whole life/permanent.
Whole life or permanent insurance has a level premium and
pays a static benefit whenever you die. For this guaranteed
benefit, whole life is usually the more expensive choice
because it front-loads its costs into the early premium
years of the policy so it can invest the money to pay for
death benefits at the end of several years or decades. At a
certain point, the policy owner will pay in enough where he
or she will start accruing cash value on that money which
can be withdrawn if the policy owner decides to cancel the
coverage. There are four types of permanent insurance:
- Whole or ordinary life.
This is the most common type of permanent insurance policy,
offering a death benefit with a savings account. You agree
to pay a certain amount in premiums on a regular basis for a
specific death benefit. The savings element would grow based
on dividends the company pays to you.
- Universal or adjustable
life. This variation offers a little more flexibility,
such as the possibility of increasing the death benefit if
you pass a medical exam. The savings product attached to
this kind of account generally earns a money market rate of
interest, and after you start accumulating money in this
account you'll generally have the option of altering your
premium payments. This helps if you lose your job or have
some other financial misfortune.
- Variable life. This
policy lets you invest your cash value in stocks, bonds and
money market mutual funds which is good if those investments
go up. If they go down, your cash value and death benefit
will shrink, but you need to make sure there's a guarantee
that your death benefit won't fall below a certain level.
This type of policy can be fairly risky for ordinary
consumers.
- Variable-universal life.
This choice allows you the flexibility of premium payments
with a more aggressive investment scenario for the cash
value of the policy.
Life insurance proceeds don't generally go into Uncle Sam's
collection plate, which makes life insurance an attractive
purchase for many individuals hoping to maximize the amount to
give to heirs. Yet life insurance can also be purchased in a way
to give the living policyholder tax-free income during
retirement. Since we're talking about estate issues here,
getting proper advice is critically important. The federal
government's current estate tax ceilings were set to expire in
2010, and this fact alone could affect the attractiveness of
this strategy for your situation.
August 2008 — This column is produced by the Financial
Planning Association, the membership organization for the
financial planning community, and is provided by Don McCarty of
Financial Decision Partners, a local member of the FPA.
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