Understanding Fin Q: The Basics Of Life Insurance Finances

Life insurance is a contract between an insurance company and a policy owner, where the insurer promises to pay a sum of money to the policy's beneficiaries when the insured person dies. In exchange, the policyholder pays premiums to the insurer during their lifetime. The two main types of life insurance are term life insurance and permanent life insurance. Term life insurance offers protection for a set period, while permanent life insurance remains in force until the insured person dies, stops paying premiums, or surrenders the policy. When considering life insurance, it's important to evaluate your financial situation, dependents, and the level of coverage needed.

What is the purpose of life insurance?

Life insurance is a contract between an insurance company and a policyholder. The purpose of life insurance is to provide financial security to your loved ones upon your death. The insurance company agrees to pay a sum of money to one or more named beneficiaries in exchange for a premium. This sum of money is often used to pay bills, living expenses, debts, college tuition, and funeral expenses.

Life insurance policies fall into two categories: term and permanent. Term life insurance offers coverage for a set number of years, such as 10, 20, or 30 years. Permanent life insurance, on the other hand, does not expire and will cover you for your whole life.

The decision to purchase life insurance is about providing financial security for yourself and your loved ones. It can give you peace of mind, knowing that you have provided a legacy and financial protection for your family. Life insurance can help replace lost income, eliminate household debt, and preserve a family business. It can also be used to supplement retirement income, fund a child's education, or protect existing assets.

Additionally, life insurance can provide tax benefits. The death benefit of a life insurance policy is usually tax-free, and the cash value of the policy can grow tax-deferred. This allows the policyholder to build savings over time, which can be withdrawn, invested, or borrowed against.

In summary, the purpose of life insurance is to provide financial security and protection for your loved ones after your death. It helps ensure that your family will have the financial resources they need to maintain their standard of living and cover any necessary expenses.

Who needs life insurance?

Life insurance is a contract between an insurance company and a policy owner. When the insured person dies, the insurance company pays a sum of money to the policy's beneficiaries. The policyholder pays premiums to the insurer during their lifetime.

Not everyone needs life insurance. Generally, life insurance is a good idea if you have family members, a spouse, or others who rely on you financially. Here are some examples of people who may need life insurance:

• Parents with minor children: If a parent dies, the loss of their income or caregiving skills could put their children at a severe disadvantage. Life insurance ensures that the children will have the financial resources they need until they can support themselves.
• Adults who own property together: If one adult dies, life insurance can help the surviving owner(s) continue to afford loan payments, upkeep, and taxes on the property.
• Seniors who want to leave money to adult children who provide their care: Life insurance can help reimburse adult children for the costs of caring for their elderly parent.
• Young adults whose parents have incurred private student loan debt or co-signed a loan for them: Although young adults without dependents rarely need life insurance, they may want to carry enough insurance to pay off any debts their parents will inherit upon their death.
• Stay-at-home spouses: Stay-at-home spouses contribute significant economic value through their domestic work. Life insurance ensures that their skills will not be costly to replace.
• Wealthy families who expect to owe estate taxes: Life insurance can provide funds to cover estate taxes and preserve the full value of the estate for heirs.
• Families who can't afford burial and funeral expenses: A small life insurance policy can provide funds to honour a loved one's passing.
• Businesses with key employees: If the death of a key employee would cause financial hardship for a business, the company may have an insurable interest that will allow it to purchase a key person life insurance policy on that employee.
• Married pensioners: Life insurance can be used in a strategy called pension maximization, where pensioners accept their full pension and use some of the money to buy life insurance for their spouse.
• People with pre-existing medical conditions: Although some insurers may deny coverage or charge high rates for individuals with pre-existing medical conditions, they may still be able to obtain life insurance.

In summary, life insurance is intended to provide financial support to surviving dependents or other beneficiaries after the death of an insured policyholder. It is important to consider your financial situation and determine how much money would be required to maintain your beneficiaries' standard of living before purchasing a life insurance policy.

How much life insurance is needed?

The amount of life insurance you need depends on your financial and family situation. It's recommended to have enough life insurance to cover your debts and replace your income, accounting for inflation. Here are some methods to calculate how much life insurance you need:

• Income Replacement Method: Multiply your annual salary by the number of years you want to replace that income. For example, if you want to replace your income for 10 years and earn $50,000 annually, you would need $500,000 in coverage.
• Mortgage and Debt Coverage: Include the balance of your mortgage and any other large debts that your family would struggle to pay off without your income.
• Future Needs: Consider future expenses such as college tuition for your children and funeral costs.
• Stay-at-Home Parent Costs: If applicable, calculate the cost of replacing services provided by a stay-at-home parent, such as childcare.
• DIME Method: This considers Debt, Income, Mortgage, and Education. Add up your debts, income multiplied by the number of years of support needed, mortgage balance, and education costs for your children.
• 10 Times Income Rule: A common guideline is to get coverage worth 10 times your annual income. However, this doesn't account for your savings, existing policies, or the needs of a stay-at-home parent.

You can also use a life insurance calculator to get a more accurate estimate of your coverage needs. It's important to review your life insurance policy regularly to ensure it still meets your needs.

What are the different types of life insurance?

Life insurance is a contract between an insurance company and a policy owner in which the insurer guarantees to pay a sum of money to one or more named beneficiaries when the insured person dies. There are two main types of life insurance: term life insurance and permanent life insurance.

Term Life Insurance

Term life insurance offers protection for a set period, ranging from one year to 30 years or more. It is designed for those who just need coverage for a certain number of years, such as while they are raising a family or have children in college. Term life insurance is generally more affordable than permanent life insurance, with premiums that stay the same for the entire term. However, if you renew at the end of the term, your premiums will increase as they are based on your age at renewal. Most companies offer term life insurance only up to a certain age, usually 70 or 80.

Term life insurance policies have two common features: convertibility and renewability. Convertibility allows you to exchange your term policy for a permanent life policy without taking a medical exam, which can be helpful if your health deteriorates after purchasing the term policy. Renewability lets you extend your policy for additional terms, regardless of your health, and without a medical exam.

Permanent Life Insurance

Permanent life insurance provides coverage for your entire lifetime, as long as you continue paying premiums. It is more expensive than term life insurance due to its savings feature and longer coverage period. Some permanent life insurance policies let you build savings over time, which can be withdrawn, invested, or borrowed against to pay premiums. This type of policy is also known as "cash value life insurance".

The two most common types of permanent life insurance are whole life insurance and universal life insurance.

Whole Life Insurance

Whole life insurance stays in effect for your entire life, provided you keep paying the premiums. It includes a savings component that grows at a fixed or variable interest rate, allowing the cash value to accumulate over time. Whole life insurance policies typically have level premiums and death benefits that remain the same each year. While whole life insurance is straightforward compared to other permanent life insurance options, it is usually more expensive than term life insurance.

Universal Life Insurance

Universal life insurance is another type of permanent life insurance that provides coverage for your entire life as long as you pay the premiums. It is sometimes called adjustable life insurance because it offers more flexibility than whole life insurance. Universal life policies allow you to increase or decrease your death benefit and adjust or skip your monthly premium within certain limits. The interest rate for the cash value is not fixed and can change over time based on market conditions.

Other Types of Life Insurance

In addition to the main types of life insurance, there are several other variations and specialty policies:

• Variable life insurance: a riskier type of permanent life insurance that combines a fixed death benefit with a variable cash value tied to investment performance.
• Final expense life insurance: also known as funeral or burial insurance, this is a type of whole life insurance with a smaller death benefit designed to cover end-of-life expenses.
• Indexed universal life insurance: a type of permanent life insurance with a cash value that grows based on a stock market index.
• Simplified issue life insurance: a type of life insurance that doesn't require a medical exam, resulting in a faster approval process.
• Instant life insurance: a specific type of simplified issue policy that offers online applications and quick decisions.
• Guaranteed life insurance: a policy that does not ask medical questions and cannot turn down your application.
• Supplemental life insurance: additional coverage beyond what a company's group life policy offers, available from employers or private insurance companies.
• Survivorship life insurance: a joint life insurance policy that covers two people and pays a death benefit once both policyholders have passed away.
• Decreasing term life insurance: a type of term life insurance with a death benefit that gets smaller over time, making the policy more affordable.
• AD&D insurance: a category of life insurance that only pays out if the insured person dies in an accident or suffers serious injuries such as the loss of limbs or paralysis.

How do you buy life insurance?

Decide if you need life insurance

Before you begin, ask yourself if you need life insurance. Most people do, especially if your family or beneficiaries would face financial hardship without your income. Other reasons to consider buying life insurance include wanting to cover end-of-life expenses, such as funeral costs, or to pay for a dependent's tuition or retirement costs.

Determine how much life insurance you need

The amount of life insurance you need depends on factors such as your income, the needs of your dependents, and your financial goals. Ask yourself questions like:

• How will the loss of my income affect my dependents?
• How much will my dependents or spouse need to cover the mortgage or rent?
• How will my loved ones cover end-of-life expenses?
• Do I want my life insurance policy to be used as an inheritance?

Determine which type of life insurance is right for you

There are two primary types of life insurance to choose from: term life and permanent life. Term life insurance provides coverage for a set period, usually between 10 and 30 years, and is more affordable. Permanent life insurance covers you for as long as you live and typically has a cash value component in addition to the death benefit.

Decide if you need life insurance riders

Riders are additional benefits or options that can be added to your policy to meet your specific needs. Common types of riders include:

• Children's Term Rider: Allows parents to cover their children under the policy.
• Accelerated Death Benefit Rider: Allows you to access your death benefits before you die if you are diagnosed with a terminal illness.
• Accidental Death Benefit Rider: Increases the death benefit paid out if you die from injuries sustained in a covered accident.
• Waiver of Premium Rider: Protects you if you can't pay the required premium due to an injury or illness that leaves you disabled.

Choose a life insurance company

You can purchase life insurance through an insurance agent, insurance broker, or directly from an insurance company. It's important to select a reputable company with strong financial ratings and positive customer reviews.

Purchase your policy

Complete the life insurance application, either online or through a physical form. You will need to provide basic contact information, specify the type of policy you plan to purchase, and designate your beneficiary/ies. You may also need to undergo a medical exam, depending on the type of policy you choose.

Prepare for your phone interview

After submitting your application, the insurance company may require a phone interview to confirm the information provided and ask additional questions about your lifestyle, financial health, and any other life insurance policies you have.

Schedule a life insurance medical exam

Many life insurance companies and policy types require applicants to undergo a physical exam. The exam is typically similar to a regular doctor's appointment and can often be done at your home or office.

Wait for approval

Once you have completed the application process, including any required interviews or exams, your job is done. The insurance company will review your information and determine your eligibility and premium. If approved, you will receive the policy documents to sign and approve.

Additional considerations:

• Riders: When choosing a life insurer, check if they offer riders that meet your needs and consider how these impact your premium and coverage.
• Financial goals: Consider the impact your death could have on meeting important financial milestones.
• Employer-sponsored coverage: If you have group life insurance through your employer, ensure it is sufficient to cover your family's financial needs. Also, keep in mind that this coverage usually ends when employment ends.
• Captive vs. independent agent/broker: A captive agent works with a single insurance provider, while an independent agent or broker can help you find the best rates by requesting quotes from multiple insurers.
• Age: The younger you are, the lower your life insurance premium is likely to be, assuming you are in good health.
• Common mistakes: Not assessing your needs before purchasing a policy can lead to having too much or too little coverage. It's important to decide which type of insurance is right for you before committing to a policy.

Frequently asked questions