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 will not 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. The death benefit of a life policy owned by a C corporation may be included in the calculation of the alternative minimum tax.
How much 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
- ongoing financial needs, such as monthly bills and expenses, day-care costs, college tuition or retirement.
Although there is no substitute for a careful evaluation of the amount of coverage needed to meet your needs, one rule of thumb used is, buy life insurance that is equal to five to seven times annual gross income.
Choosing a Plan
Buying life insurance is not like any other purchase you will make. When you pay your premiums, you’re buying the future financial security of 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 other major purchase, it is important that you understand your needs and the options available to you.
The main types of life insurance available are term and permanent. Term life insurance provides protection for a specified period of time. Permanent life insurance provides lifelong protection. To learn more about term and permanent life insurance click on the appropriate button at the top of this page.
1. What happens if I fail to make the required payments?
If you miss a premium payment, you typically have a 30- or 31-day grace period during which you can pay the premium. After that, the policy will lapse. You may be able to reinstate with evidence of insurability depending on your policy’s provisions. If your policy has sufficient cash value, the company can, with your authorization, draw from a permanent policy’s cash surrender value to keep that policy in force. This does not apply to term insurance because there is no cash value to draw from. In some flexible premium policies, premiums may be reduced or skipped as long as sufficient cash values remain in the policy. However, this will result in lower cash values.
2. What if I become disabled?
Provisions or riders that provide additional benefits can often be added to a policy. One such rider is a waiver of premium for disability. With this rider, if you become totally disabled for a specified period of time, you do not have to pay premiums for the duration of the disability.
3. Are other riders available?
- “Accidental death benefit”, provides for an additional benefit in case of death as a result of an accident.
- “Accelerated benefits”, also known as “living benefits.” This rider allows you, under certain circumstances, to receive the proceeds of your life insurance policy before you die. Such circumstances include terminal or catastrophic illness, the need for long-term care or confinement to a nursing home.
- “Child rider”, provides insurance for all your children, usually from $1,000 to $20,000 of death benefit.
- (availability, specifics, and costs of these riders vary by carrier and state.)
4. When will the policy be in effect?
If you decide to purchase the policy, find out when the insurance becomes effective. This could be different from the date the company issues the policy.
5. How do accelerated death benefits work?
It allows policyholders to receive all or part of the policy’s proceeds prior to death under certain circumstances, including the need for long-term care and confinement to a nursing home. Because payments may affect tax status and Medicare eligibility, and will be deducted from the overall benefits paid later to beneficiaries, policyholders should thoroughly investigate options in advance.
6. By using medical tests are insurers trying to eliminate any applicant likely to develop a serious health condition?
Medical tests can provide accurate and current information about an applicant’s health, thus enabling insurers to charge premiums that reflect the level of risk an applicant represents. Because some health conditions are easily managed through proper medication, therapy or lifestyle changes, medical information sometimes makes it possible for insurers to cover applicants who might not otherwise be insurable. More serious or incurable conditions present an enormous risk that an insurer simply cannot assume.
7. What should I consider in naming life insurance beneficiaries?
- Always name a “contingent,” or secondary, beneficiary, just in case you outlive your first beneficiary.
- Select a specific beneficiary, rather than having the proceeds of your life insurance paid to your estate. One of the great advantages of life insurance is that it can be paid to your family immediately. If it is payable to your estate, however, it will have to go through probate with the rest of your assets.
- Be very clear in wording beneficiary designations. Naming specific children may exclude those born later. If your child dies before you, do you want the proceeds to go to that child’s children? Changing the beneficiary designation is easy, but you have to remember to do it.
8. Does it make sense to replace a policy?
Think twice before you do, because in many situations it may not be to your advantage. Before dropping any in-force policy, make sure your “new” policy is paid for and in effect and first consider:
- If your health status has changed over the years, you may no longer be insurable at preferred or standard rates.
- Even if both policies pay “dividends,” it may be years before the new policy’s dividends equal those of your present one.
- If you replace one cash-value policy with another, the cash value of the new policy may be relatively small for several years and may never be as large as that of the original one. There may also be a period wherein a surrender charge is applicable on the first policy.
- You should ask for a detailed listing of cost breakdowns of both policies, including premiums, cash surrender value and death benefits. Compare these as well as the features offered by both policies.
- If you decide to surrender or reduce the value of the policy you now own and replace it with other insurance, be sure your new policy is in force before you cancel the old one.
9. As a single person, do I need insurance?
- The answer almost always is yes. You may want to consider these options:
- Disability income insurance – especially important for self-supporting singles without sizable assets, this can replace a good part of the income you would lose if you were unable to work because of accident or illness. If you don’t have long-term disability coverage at work, it would be wise to consider an individual policy designed to replace at least 60 percent of your income.
- Health insurance – if you don’t have on-the-job coverage, an individual policy is your first line of defense against ever-escalating medical and hospital costs. You can keep premium costs down by electing a large deductible, thereby “self-insuring” as much as you can afford.
- Life insurance – even if you have no dependents now, you may later. If you buy now when you are younger and healthier, you can “lock in” lowest-cost coverage, including guaranteed insurability.