Life Insurance 101: What is Life Insurance?
You work hard. You have a good job, you’re making good money and you’d like for your family to enjoy the fruits of your labor throughout their future. Preparing for your family’s future, however, means more than simply appropriate investing. For many people, preparing is and should involve purchasing the right amount of life insurance.
Put simply, life insurance protects your family’s future. Life insurance helps to mitigate the financial impact on your loved ones in the event of your death. With a life insurance policy, your family can use the proceeds to help replace lost income, eliminate debt, pay for college, keep a business afloat, or address other financial needs and goals while they adjust to a new life.
What is life insurance?
A life insurance policy provides a payment in the event of your death that helps to protect your family’s lifestyle in your absence and in the absence of your income and/or earning power. For example, many people with financial obligations —such as paying off a mortgage, putting a child through college, or supporting an elderly parent— would be dependent upon a life insurance policy to meet such obligations in the event a spouse’s unexpected death. Life insurance can help support family goals.
How does life insurance work?
When you purchase a life insurance policy, you’re essentially buying a contract with the issuing insurance company. The issuing insurance company guarantees that upon your death, it will pay a preset amount to your beneficiaries, i.e.: your pre-designated loved ones. Typically, death benefits are free from income taxes. The insurance company pays your beneficiaries directly, so your beneficiaries receive the funds without the delays and expenses associated with a will. Depending on the size of your estate, benefits from a life insurance policy may be subject to estate tax.1
Life insurance policies fall into two general categories: Term and Permanent.
A term life insurance policy provides coverage for a specific period of time, typically ranging between 10 and 30 years. At the end of that period, or term (hence the name), you stop paying premiums and your coverage ceases.
A permanent life insurance policy covers you until your death, regardless of age—so long as your premium payments are up to date. Permanent life insurance generally includes an investment component along with the insurance policy, which generally results in higher premiums.
Permanent life insurance is commonly used for wealth transfer and estate planning purposes, while term life insurance is used for replacing lost income in the event of premature death.
Term life insurance is generally more affordable, and in many cases more appropriate, for most purchasers. Affordable term life insurance enables you to access a quality life insurance policy for far less money than a permanent insurance plan. A good and helpful comparison is leasing a car versus buying one: You can often get a more expensive car for the same payment by leasing, rather than buying the vehicle.
When should purchase life insurance?
If someone else, or multiple people (like a family) are dependent upon your income, that means you need a life insurance policy. Thus, the time is now.
You may already have some life insurance coverage through your employer. Even so, it’s usually a good idea to consider purchasing additional coverage independently, because policies you buy outside an employer’s plan are portable, meaning your coverage continues even if you lose or leave your job. Plus, your employer’s coverage may not meet your financial obligations.
It’s a good idea to review your life insurance needs whenever a major life event occurs. Here are some examples of major life events:
- The purchase of a new home, or undertaking major improvements to your current home.
- Marriage. A wedding should prompt you to review your entire financial situation, including your income needs, debt, and other liabilities, and to add a layer of protection for both spouses.
- Children. A life insurance policy can provide protection for your family’s increased income needs and any debt you may have taken on, including college expenses.
- New job. A term insurance policy can replace any group coverage you may have had from a former employer, and enable you to increase your coverage amount in accordance with your new salary.
For families with children, if one spouse is a homemaker, it may be important to have life insurance for that spouse in addition to insuring the primary wage earner. Consider the value of the stay-at-home parent and the services he or she provides. If a premature death were to occur, in addition to being a devastating loss, it would put a tremendous financial strain on your loved ones and might impact the working spouse’s ability to continue to earn the same living.
Cheap term life insurance can cover future college expenses, funeral and estate expenses, and even business ownership needs. (Small businesses may wish to consider purchasing key employee life insurance policies, such as an owner or top employee, to help prevent financial distress if that person were to die.)
As you consider purchasing a life insurance policy, keep in mind that you will undergo a medical examination to ensure your insurability. Don’t sweat. These examinations are not the end-all-be-all, but they are important. Generally speaking, the better your overall health, the lower your premium will be. Low blood pressure and low cholesterol, along with a healthy body weight, will typically lead to a lower premium. Thus, as you can deduct, it’s easier and more cost-effective to buy life insurance in your twenties and thirties than in your forties, fifties, sixties, and so on.
How much life insurance do I need?
There are several ways to go about determining how much coverage you need. One simple method is to buy coverage equal to 5 to 10 times your annual salary, bonuses, etc. Following this rule of thumb, if you make $50,000 annually, you’d buy a policy between $250,000 and $500,000.
However, we believe the best method for determining how much coverage you need is by speaking to an experienced broker. The broker will know which questions to ask and exactly how to ensure your insurance plan is tailored specifically for your and your family’s needs. Call a Term Life Match agent today, we are ready to assist you!