Why buy life insurance?
Generally speaking, people buy life insurance to protect against the
loss of life of a wage earner: life insurance is meant to replace
that person’s lost income. Since the proceeds of life insurance
are tax-free, it needs to be considered as part of your overall financial
planning picture, in particular surrounding its relationship with
estate planning, retirement funding, cash accumulation, and the transfer
of wealth to beneficiaries.
Before buying, you need to be able to answer the following questions:
• How much life insurance do you need? In other words, if you died, what
would your dependents need in order to live comfortably?
• How much can you afford to pay for a policy?
• Will the life insurance cover just replacement income, or more? For
example, are you looking to fund future education costs, to pay estate
taxes, to supplement retirement or be available for emergencies?
Make sure, as well, that the life insurance company you choose is financially secure, well rated by industry experts, and has a good claims payment history and competitive pricing.
Types of life insurance
As with all financial products, there are many types of life insurance
available today, and the cost and features of any given policy depend
on the type of policy, the insurance company itself, and how they
evaluate you as a policyholder. Once you’ve identified the type
of insurance that’s right for you, shop around, since life insurance
is a long-term commitment.
Term Life Insurance
Term life insurance, also known as temporary insurance, covers you
for a specific time period that you select (eg. 10 or 20 years).
Benefits
are paid only if you die during this time period of coverage. Term
life policies do not accumulate any cash value either, which means
that if you do not die within the time you’re covered, your
estate does not collect any money from the policy when it ends.
With term life insurance, most insurance companies offer a conversion privilege. This allows you to convert your term life policy into a permanent policy. Why is this important? Read on!
Term life policies offer certain advantages, as follows:
• They cost less than permanent insurance.
• Any proceeds paid are not taxable to your beneficiaries.
•
While in effect, you typically can convert term policies to a permanent
policy without having to give evidence of insurability (that's an official
statement proving you're an insurable risk – read on to see
why this can be very important).
• You can buy a large amount of term insurance to complement your permanent
policy.
• Term life policies can be a good supplement to employer-sponsored life
plans, or older policies that may be inadequate due to inflation.
Permanent Life Insurance
Permanent life insurance differs from term insurance in two key ways:
it provides lifetime coverage and it lets you build cash value over
time. The cash value accumulated (with interest) from a portion of
your premium can be used to send children to college, fund an emergency,
or pay for a major purchase.
The advantages of permanent life insurance are as follows:
• Premiums remain constant over your lifetime.
• You can accumulate cash value, tax deferred.
• You can withdraw or borrow accumulated cash value.
• Death benefits are paid when you die. Some companies will also advance
death benefits to help pay for nursing care or terminal illness expenses
(note that some term life policies offer this as well)