When someone depends on your income, life insurance is necessary protection against loss of income. If you died suddenly, your family would have to try to pay all of their financial responsibilities while dealing with the emotional impact of your death.
Life insurance is not about investment strategies or complicated financial products. Life insurance is about replacing the income of the insured and protecting the dependent(s) on the income of the insured.
In general, life insurance is a contract in which you pay a premium to an insurance company in exchange for a promise from the company to pay out a specified amount of money if you die in the term of the contract.
The money paid out to your beneficiary(ies) is called the death benefit.
Generally, your beneficiary(ies) will be your closest living relatives (spouse, partner, children); however, depending on the circumstances you may also choose to designate a business partner or a trust as your beneficiary(ies).
The purpose of the death benefit is to replace the income that your family would lose if you were to die.
However, life insurance isn’t necessary for everyone.
For example, take an individual who is single, aged 25, and has no children or spouse with whom they share finances. Therefore, life insurance isn’t a financial priority for them yet.
Now fast-forward 20 years. That same person is now married with children, and a mortgage; their financial responsibilities are now much larger. If this person were to pass away unexpectedly, their family would likely have trouble meeting everyday financial obligations.
This is why life insurance becomes very important.
Life insurance cost is determined by many different factors.
One of the largest factors is the size of the policy i.e any “death benefit” amount (the larger the amount desired, the higher premium).
Another large factor is the individual’s age. Insurance companies understand that with age comes an increased risk of death, and therefore higher premiums.
Individual health also affects rates. Individuals who are in good health and have no chronic medical conditions will qualify for lower rates than individuals who smoke or have serious health problems.
Also, the type of life insurance policy chosen will determine the price of the policy.
Whole and Term Life Insurance – Two Types of Life Insurance that are the Most Discussed
When it comes to life insurance, the two biggest options you will find are Term Life and Whole Life.
Term life insurance is generally the easiest to understand. You purchase a policy that covers you for a specified period of time, typically 10, 20, or 30 years. While the premium is guaranteed throughout the term, your death benefit will also remain the same for the duration of the policy; therefore, any paid-out claim during the policy term will be paid to your beneficiaries based on the face amount of the policy.
If you die while you have a term policy, your beneficiaries will be paid your full benefit. If you survive the term, your term policy simply ends and you will not receive anything for the premiums you’ve paid.
Because of the simplicity of term policies, term life insurance typically has a much lower premium compared to other policies.
Whole life insurance works on a different foundation.
Whole life policies provide a guarantee for the insured’s entire life. In addition to providing a death benefit, whole life policies accummulate a cash value (a savings type of account) based on part of the premium paid.
With each premium payment made, part of the payment goes towards providing the insurance coverage on the insured while part of the payment goes to increasing the cash value of the policy (which will continue to accumulate after the policy has been purchased).
As time progresses cash value accumulates through interest paid by the insurer.
However, it should be noted that the initial cost of whole life policies are much higher than term life policies, with some policies having monthly premiums costing many multiples of other policies providing identical death benefits.
Another surprise regarding whole life insurance policies is with what occurs to the accumulated cash value at the time of death.
It is common for consumers to believe that both the cash value and death benefit will be paid to their beneficiaries; in reality, most examples of whole life insurance provide for only one of these payments – either the cash value or the benefit amount, with the greater amount paid.
The insurer will keep the lesser amount of accumulated cash value at the insured’s death.
There are options available with certain whole life structures that provide for both payouts but will be priced significantly higher than traditional whole life.
In addition to the payout options, whole life policies allow the policyholder to take out loans from the policy while living.
However, loans are considered as withdrawals on the policy, and will incur interest, and should the loan remain unpaid, the unremitted amount will be deducted from the total death benefit.
For example, should a large loan be taken from the policy prior to the insured’s death, the death benefit would be reduced to reflect the unpaid loan.
Due to the varying principles behind both types of coverage, a great deal of scepticism surrounds the concept of whole life insurance and term life insurance. Therefore, many recommend term life insurance as the ideal choice for most families – this comes from the traditional reasoning.
A term policy usually has a much larger benefit amount and relatively low premium on an annual basis which allows families to protect themselves during their highest financial responsibilities such as raising children or paying off a mortgage to ensure that adequate funds will be available in the future. However, instead of using the higher annual premium of whole life insurance to purchase whole life insurance for family protection, it is recommended that the high premiums of whole life insurance be used to invest in retirement accounts and other savings vehicles.
Essentially, your insurance protects your family and your savings will accumulate wealth for you. However, it should also be noted that whole life insurance may not always be a bad option.
Under normal conditions, life insurance is not meant for clever financial tactics. It is meant to provide financial protection to your loved ones if something were to happen to you.
In rare cases, such as individuals with large estates, cash value policies may have their uses, including potential tax benefits.
But for the average person, these types of situations do not apply, so at the end of the day, it’s about providing peace of mind to your loved ones that they will be taken care of after you die.
If you support a family with your income, or have a mortgage payment, or help pay for daily living expenses, the right life insurance will make a tremendous positive impact on the lives of those you support if you died prematurely.
