Guide to Life Insurance
The decision to get life insurance depends largely on your current situation, like your age (30s, 40s, 50s), family status, and your earnings. A financial advisor will ensure that protection, like life insurance, is a part of your financial plan. They will work with you to ensure that you select the best life insurance coverage to fit in with your holistic financial plan.
This guide covers the basics of life insurance, including:
– What is life insurance?
– Why do I need life insurance?
– Types of life insurance:
– Term life insurance
– Permanent life insurance
– How much life insurance do I need?
– How do I go about getting life insurance?
Consider this: You buy yourself a car. You pay a monthly insurance fee so that if the car is stolen, the insurance company pays you out the value at which you insured it. You replace your car.
Life insurance works in more or less the same way. You insure your life i.e. your future earnings. You pay a fee (or a “premium”) to the insurance company if you lose your life the insurance company pays out the value for which you insured your life and gives it to your family or dependents. The main difference between normal asset insurance (like car insurance) and life insurance is that you can choose how you’re paid out. You can get a lump sum payout (as you would with car insurance) which is called a “death benefit” or the death benefit plus a smaller, continuous monthly payout (annuity). Often times the death benefit is non-taxable at the federal level so if you buy a million dollars in life insurance, your beneficiaries will receive a million dollars tax-free.
When you buy an asset, like a car or a home, you insure the asset so that in the event of it being stolen, damaged or destroyed, you have access to sufficient cash to replace or repair it. Life insurance is there to protect THE most important asset you have. You!
Let’s assume that you are a 35-year-old doctor, your current annual income is $250,000 and you plan on retiring at age 60. This means that your career potential is around $5 million i.e. if you work until 60 you will have earned $5 million. That’s a lot of money! Congrats!
If you were buying a $5 million valued house, you would probably make sure to insurance it, right? Well, the same logic applies to your life.
Our guess is that you have some great plans for the earnings you expect to receive. Maybe you want to ensure you and your spouse have enough to comfortably retire or send your kids to college? Well, life insurance ensures that those plans don’t get derailed if you are not around.
When an income earner passes away, the survivors are often left to make drastic changes to their lifestyle at a very emotionally difficult time. Having sufficient life insurance can provide financial peace of mind during such a time.
Types of life insurance
There are many different types of life insurance: universal, term, variable, whole, renewable, convertible… the list goes on and on. But in essence life insurance can be broken down into two general categories: Term & Permanent.
Term life insurance
As the name suggests, Term Insurance works with a set term or period of time e.g. 10-year, 30-year, etc. Term insurance is generally used to protect against premature death that will pay the death benefit if the policy owner passes away within the set term. So your family (dependents) will get paid a lump sum of the total amount you insured your life for. There are pros and cons to this type of life insurance.
Least expensive type of life insurance
It will allow you to buy a large death benefit amount for significantly
less than a permanent policy. Term insurance is simple and therefore you don’t have to worry about hidden fees or complex investments within the policy. The most important reason to get life insurance is to protect your future earnings so that you can still provide for your family if you were to pass away. For most people, term insurance is enough.
Disadvantage: Term limitations
It only pays the death benefit if the policy owners die during the policy term i.e. if you die a day after the policy end date, no death benefit is paid to your beneficiaries. Keep in mind that your greatest need for life insurance is when your children “depend” on you, so term insurance when you are 65 is not as important to have versus when you are 40 because ideally, you will be able to “self-insure” by the time the policy ends.
If your term comes to an end and you are still alive, you have the choice to either go without life insurance or be underwritten for an additional term (often at a higher premium). Additionally, the premiums already paid are also kept by the insurance company – similar to a car insurance policy.
Permanent life insurance
As opposed to coverage for a set amount of time like term insurance, permanent insurance is put in place for the entire life (until death) of the policy owner. So no matter when the policy owner dies, the life insurance will be in effect. In addition, permanent policies allow a portion of the premiums paid to accumulate into a pool of money, known as the “cash value” that can be accessed before death. Permanent life comes in many different forms including whole, universal, and variable with the main difference being how much cash value can be accumulated and how it is managed by the insurance company or policy owner.
Advantage: Cash Value
The advantage of permanent insurance is the cash value. The cash value is essentially a fund that grows as you make your annual contributions. As the policyholder, you are able to access this fund. This money can be used towards a number of different goals, can earn a return and grow, and is given preferential tax-deferred treatment. It is an extra source of cash in addition to the death benefit that will be paid out upon death.
Disadvantage: More expensive
It is much more costly than term insurance since…
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