Life Insurance Basics & Where to Go to Dive Deeper
Knowing your life insurance basics is an important part of your financial planning. Here is what is most important to know, so you can make the best decisions for your future.
What is Life Insurance?
Life insurance is a way to protect yourself and your family from financial loss in the event of a death.
It is a contract with a life insurance company (also called a “carrier”). You pay monthly premiums in exchange for financial protection in the event of a death.
Basic Use of Life Insurance
Here is an example of a basic use of life insurance for a family.
- To start, let’s say you are concerned about your financial status if your spouse where to pass.
- You take out a life insurance policy for $500,000 on your spouse.
- Then, you will pay monthly premiums for a set amount of time, or until you decide you do not need the death benefit anymore.
- If your spouse dies while the policy is “in force” (active), then you will receive $500,000.
- Depending on if it is a term or whole life policy, there are different benefits and different ways for the policy to continue or to end. Let’s discuss these different types of life insurance next.
Why Do I Need Life Insurance?
This is Life Insurance Basics 101 – Life has responsibilities and obligations, and the more you have, the more protection you may need.
- For example, people consider securing protection from life insurance for: mortgages, rents, living expenses, college savings, retirement savings, paying off debts, paying taxes (i.e. estate taxes), giving to charities / churches, and/or paying for funerals and burials.
In addition, life insurance can be used for retirement planning and for Long-Term Care costs. For these purposes, you will need a certain type of insurance: whole life insurance. So, let’s start there.
What is Whole Life Insurance?
Often called “traditional insurance” or “permanent life insurance”, whole life insurance is a contract that is active until death. It has a cash value as well as a death benefit.
The insurance company expects the policy holder to pay premiums for the whole life policy until death occurs (or the policy is deactivated).
Whole life premiums are level, meaning that they do not go up year to year. In addition to the death benefit, which is also called the “face value,” the policy accrues cash inside of it. You can access this cash for loans against the policy.
- Click to read more about Indexed Universal Life Insurance – a newer type of permanent insurance. It is often used for retirement planning in addition to more traditional life insurance uses.
- There is also Modified Whole Life Insurance.
What is Term Life Insurance?
Term is life insurance designed to expire at some point if death does not occur first. For example, you can design a policy to stay in-force or active for 10, 15, 20 or 30 years.
In regards to term life insurance basics, you pay monthly premiums to keep the policy active. In addition, these premiums may go up or down year to year depending on how you and the insurance company structure your policy. There is no cash value in a term policy.
Term vs Whole Life Insurance – Pros and Cons
What are the benefits to having one type of policy over the other? Well, there are pros and cons to both term and whole life insurance. Let’s look at each.
Term Life Insurance Benefits – “The Pros”
- Affordability: Term life insurance is affordable. Since there is no permanent value to a term life policy, the premiums are less expensive than a whole life policy of the same face value. In other words, you can get a larger death benefit payout amount for less money paid in each month.
- Flexibility: You can structure your term policy according to your needs. You can play with the face amounts, the premiums paid, and the length of time needed to structure a policy that meets your needs.
Term Insurance Limits – “The Cons”
- Temporary Coverage: First, the major “con” of a term life policy is that it will end at some specified point, leaving you uninsured and with no lasting value from having the policy.
This is okay, because the policy will have done it’s job to protect you when you were most vulnerable financially, but it is good to note that it will end. (The policy offers temporary protection, but insurance carriers have not structured it to offer long-term planning or retirement cash flow options.)
- Increasing Premiums: The second consideration is term policy premiums can often go up year to year. Unless you choose a “level-term premium” option, your policy may start off completely affordable, but become more expensive as you age. (This makes sense because your mortality rates increase as you age. It’s just part of the game.)
Whole Life Insurance Benefits – “The Pros”
- Permanent Coverage: The main benefit of owning a whole life insurance policy is that it is permanent insurance. It is not designed to terminate at a point in time.
- Cash Value: Second, a pro of whole life insurance is that it becomes more valuable with time. As you hold the policy and pay your premiums, you will accrue a cash value inside the policy. Depending on how you structure your policy with your carrier, the face value may continue to go up as your cash value increases. In addition, you will have access to this cash for taking out “loans” against the policy. Many people use these loans for one time purchases, or as a source of funding in retirement.
- Long-Term Care Money: Finally, whole life policies have the benefit of adding additional riders to meet other needs. For example, many whole life policies now have the ability to add a critical illness or long-term care rider. In these policies, you can use your life insurance to pay for qualified assisted living, nursing home and end-of-life care with access to not just the cash value, but also the face value or the policy with accelerated benefits.
Whole Life Limits – “The Cons”
- Expensive Premiums: Whole life is more expensive than term insurance because it is considered permanent and it also accrues a cash value.
- Long-Term Payments: You need to make sure you can afford to keep paying the premiums on a whole life policy. The policy will end if you stop paying the premiums. If there is a chance that you may not be able to sustain the higher premiums on a traditional policy, then you should consider term instead. Term premiums are cheaper. Moreover, some companies offer the ability to convert their term policies to permanent policies at specific times in the future with no extra underwriting.
When Should I Get Life Insurance?
There are many different times in life that life insurance benefits can be useful. However, the time to buy life insurance is when you are healthy enough to get it. Buying life insurance often requires going through underwriting, and you will need to be able to pass underwriting requirements to get a policy.
Times People Buy Life Insurance
People buy whole life policies on their kids. These provide small amounts of insurance to cover costs in the event of a death. Or, they are permanent policies kids can keep and often have the ability to add to when they are older.
- Starting a Family
Protecting your loved ones when you are in your earning years is an important function of life insurance. Make sure to buy it when you are healthy enough to get it. Often, people will buy life insurance even before they are married or have kids – just to make sure they will have it in case they end up with an illness that makes them uninsurable later.
- Planning for Retirement
You can purchase whole life policies, such as Indexed Universal Life Policies, to help you plan for retirement. People often buy these later, when they have the funds to pay for the premiums. However, you still need to pass underwriting and pay for the cost of insurance at whatever age you are buying them. Younger applicants still have cheaper costs of insurance.
- Planning for Long-Term Care
You can apply at any time for a whole life insurance policy that has riders for long-term care or critical illness. Again, you just need to be able to pass underwriting.
- Planning for Final Expenses
Finally, you can buy final expense insurance – also known as burial or funeral insurance – at any time. These are also whole life policies. However, the are often for smaller amounts and can have less stringent underwriting requirements and even guaranteed issue.
What Does Life Insurance Cost?
Life insurance premiums can be just a few bucks a month to thousands a month. It depends on your health, your age, the amount of death benefit you want, and what else you need from your policy.
Life Insurance Basics FAQ’s
Who are the parties to an insurance policy or contract?
So, who are the people involved in a life insurance contract? Let’s take a look at who is the beneficiary, the insured, and the policy owner.
- First, what is a Beneficiary?
The person or people who collects the benefit in the event of the insured’s death.
- Then, who is the Insured?
The insured is the person who’s life is insured. If they die, then the policy activates the death benefit.
- Finally, who is the Policy Owner?
The policy owner is the person who owns the policy and usually pays for it. They may or may not be either the insured or the beneficiary.
What are the parts to an insurance contract?
Insurance companies issue insurance policies to people looking to protect against losses. The life insurance basic policy parts include face values, death benefits, premiums, and sometimes cash values. Let’s look at what each of these elements do.
- What is an Insurance Policy?
An insurance policy is a contract or agreement between an insurance company and its clients to provide indemnification (compensation for loss) if and when a specified event occurs.
- What is a Carrier?
Carrier is another name for an insurance company.
- What is Premium?
Premium is a contracted amount of money paid to an insurance company to keep an insurance policy active. Usually, premiums are paid monthly. They can be level, or change year to year, depending on the insurance policy contract.
- What is a Death Benefit?
The death benefit is the amount of money the beneficiary/beneficiaries receive in the event of the death of the insured.
- What is a Face Value?
The face value is the amount of money the insurance contract is worth in the event of a death or if the policy matures before a death occurs.
- What is Cash Value?
If you have a whole life policy, you will also have a cash value in addition to the face value of the policy. The cash value is an amount of money builds up inside of the policy as you hold the policy and pay your premiums. Further, as outlined by each policy, you will most likely have access to this cash to take out loans against the policy if needed.
When it comes to life insurance basics, if you understand what term and whole life insurance policies are and what they do, you have a great head start.
People of all ages can use life insurance to round out their financial planning. From providing for family needs, to retirement and long-term care planning, to offering cash for final expense needs, life insurance works hard from many angles.
If you are ready to find a policy that fits your needs, we suggest talking to an independent insurance agent that can show you multiple options.