Buying Life Insurance
Buying life insurance is not like any other purchase you will make. When you pay your premiums, you're buying the future financial security for your family that only life insurance can provide.
Buying life insurance is not like any other purchase you will make. When you pay your premiums, you're buying the future financial security for your family that only life insurance can provide. Among its many uses, life insurance helps ensure that, when you die, your dependents will have the financial resources needed to protect their home and the income needed to run a household.
Choosing a life insurance product is an important decision, but it often can be complicated. As with any major purchase, it is important that you understand your needs and the options available to you.
Life insurance also can be used to help with other financial goals, such as funding retirement or education expenses. However, it is important to remember that the main purpose of life insurance is financial protection. If your primary goals are something other than protection, you should consider what other financial products are available to meet those goals. The best way to make an informed decision about buying life insurance is to become familiar with the basics.
Why do I need life insurance?
Life insurance is an essential part of financial planning. One reason most people buy life insurance is to replace income that would be lost with the death of a wage earner. The cash provided by life insurance also can help ensure that your dependents are not burdened with significant debt when you die. Life insurance proceeds could mean your dependents won't have to sell assets to pay outstanding bills or taxes. An important feature of life insurance is that no income tax is payable on proceeds paid to beneficiaries.
How much life insurance do I need?
Before buying life insurance, you should assemble personal financial information and review your family's needs. There are a number of factors to consider when determining how much protection you should have.
These include: any immediate needs at the time of death, such as final illness expenses, burial costs and estate taxes; funds for a readjustment period, to finance a move or to provide time for family members to find a job; and ongoing financial needs, such as monthly bills and expenses, day-care costs, college tuition or retirement.
What is term insurance?
Term insurance provides protection for a specific period of time. It pays a benefit only if you die during the term. Some term insurance policies can be renewed when you reach the end of a specific period, which can be from one to 20 years. The premium rates increase at each renewal date. Many policies require that evidence of insurability be furnished at renewal for you to qualify for the lowest available rates.
What is permanent insurance?
Permanent insurance provides lifelong protection and is known by a variety of names, described later. As long as you pay the necessary premiums, the death benefit always will be there. These policies are designed and priced for you to keep over a long period of time. If you don't intend to keep the policy for the long term, it could be the wrong type of insurance for you.
Most permanent policies including whole, ordinary, universal, adjustable and variable life have a feature known as "cash value" or "cash surrender value". This feature, which is not found in most term insurance policies, provides you with some options:
You can cancel or "surrender" the policy "in total or in part" and receive the cash value as a lump sum of money. If you surrender your policy in the early years, there may be little or no cash value. If you need to stop paying premiums, you can use the cash value to continue your current insurance protection for a specific period of time or to provide a lesser amount of protection to cover you for as long as you live. Usually, you may borrow from the insurance company, using the cash value in your life insurance as collateral. Unlike loans from most financial institutions, the loan is not dependent on credit checks or other restrictions. You ultimately must repay any loan with interest or your beneficiaries will receive a reduced death benefit.
What are the types of permanent insurance?
There are many different types of permanent insurance. The major ones are described below:
Whole Life or Ordinary Life
This is the most common type of permanent insurance. The premiums for a whole life policy must be paid periodically in the amount indicated in the policy. These premium amounts generally remain constant over the life of the policy.
Universal Life or Adjustable Life
This variation of permanent insurance allows you, after your initial payment, to pay premiums at any time, in virtually any amount, subject to certain minimums and maximums. You also can reduce or increase the amount of the death benefit more easily than under a traditional whole life policy. (To increase your death benefit, you usually will be required to furnish the insurance company with satisfactory evidence of your continued good health.)
This type of permanent policy provides death benefits and cash values that vary with the performance of an underlying portfolio of investments. You can choose to allocate your premiums among a variety of investments that offer varying degrees of risk and reward stocks, bonds, combinations of both, or accounts that provide for guarantees of interest and principal. You will receive a prospectus in conjunction with the sale of a variable product.
What are the advantages and disadvantages of term and permanent insurance?
Initially, premiums are generally lower than those for permanent insurance, allowing you to buy higher levels of coverage at a younger age when the need for protection often is greatest. It's good for covering specific needs that will disappear in time, such as mortgages or car loans.
Premiums increase as you grow older. Coverage may terminate at the end of the term or may become too expensive to continue. Generally, the policy doesn't offer cash value or paid-up insurance.
As long as the necessary premiums are paid, protection is guaranteed for your entire life. Premium costs can be fixed or flexible to meet personal financial needs. Policy accumulates a cash value that you can borrow against. (Loans must be paid back with interest or your beneficiaries will receive a reduced death benefit.) You can borrow against the policy's cash value to pay premiums or use the cash value to provide paid-up insurance. The policy's cash value can be surrendered' in total or in part for cash or converted into an annuity. (An annuity is an insurance product that provides an income for a person's lifetime or for a specific period of time.) A provision or "rider" can be added to a policy that gives you the option to purchase additional insurance without taking a medical exam or having to furnish evidence of insurability.
Required premium levels may make it hard to buy enough protection. It may be more costly than term insurance if you don't keep it long enough.
When you apply for life insurance, you may be asked to have a medical exam. Often, a licensed medical professional will make a personal visit.
Here are some other questions you should ask:
Does this policy truly meet my needs?
If your agent recommends a term policy, consider the following:
How long can I keep this policy?
If you want the option to renew the policy for a specific number of years or until a certain age, ask your agent about the terms of renewal of the contract.
When will my premiums increase?
Or after a longer period of time, such as five or 10 years?
Can I convert to a permanent policy?
Some policies allow you to convert the policy to permanent insurance without a medical exam, regardless of your physical condition at the time of the conversion. These policies are known as "convertible term."
Can I commit to these premiums over the long term?
Make sure you know the amount you would receive if you surrender your policy. Keep in mind that permanent insurance is designed to provide protection for your entire life. If you don't plan to keep the product for many years, consider another type of policy. Cashing in a permanent policy after only a couple of years can be a costly way to get insurance protection for a short term.
What does my policy illustration show?
An illustration shows policy premiums, death benefits, cash values and information about other items that can affect your cost of obtaining insurance. Some of the items listed in the illustration are used by the insurance company to reduce your costs if its future financial results are favorable. Your policy may provide for dividends to be paid to you as either cash or paid-up insurance. Or it could provide for interest credits that could increase your cash value and death benefit or reduce your premium. These items are not guaranteed. Your costs or benefits could be higher or lower than those illustrated, because they depend on the future financial results of the insurance company. With variable life, your values will depend on the results of the underlying portfolio of investments.
Ask your agent for an explanation of the illustration; some figures are guaranteed and some are not. Remember that the insurance company will honor the guaranteed figures regardless of its future financial experience.
If your policy is a variable life policy, be sure that the interest rate assumed is reasonable for the underlying investment accounts to which you choose to allocate your premiums. For example, some investment advisors suggest that a higher interest rate assumption may be warranted if you plan to allocate your premium to a stock account, while a lower rate should be assumed for more conservative alternatives.
It is important to keep in mind that an illustration is not a legal document. Legal obligations are spelled out in the policy itself.
Here are a few tips to keep in mind about your life insurance purchase:
Take your time. On the other hand, don't put off an important decision that would protect your family. Make sure you fully understand any policy you are considering and that you are comfortable with the company, agent and product. Don't rush into a decision just because you are feeling pressured. When you purchase a policy, make your check payable to the insurance company, not to the agent.
Be sure you are given a receipt.
After you have purchased an insurance policy, keep in mind that you may have a "free-look" period usually 10 days after you receive the policy during which you can change your mind. During that period, read your policy carefully. If you decide not to keep the policy, the company will cancel the policy and give you an appropriate refund. Ask your agent.
Review the copy of your application contained in your policy. Promptly notify your agent or company of any errors or missing information. If an agent or company contacts you and wants you to cancel your current policy to buy a new one, contact your original agent or company before making any decisions. Surrendering your policy to buy another could be very costly to you.