Life Insurance: Your Guide to the Basics

You might be young and healthy and wondering if life insurance is for you. The reality is — like the last year and a half has shown us — anything can happen. You don’t want your family to be left scrambling to pick up the pieces after your untimely death. That’s why life insurance is really a necessity in today’s day and age.

The Case for Life Insurance

If someone depends on you financially, it’s a good bet that you need life insurance. Life insurance provides a cash benefit to your family, in the event of your untimely death. This money can be lifesaving and help cover daily living expenses, pay the mortgage and other outstanding loans, fund tuition, and ensure that your family isn’t saddled with debt. Having a life insurance policy could mean the difference between your spouse or children having to sell assets to pay bills or sleeping soundly knowing you took good care of them. 

Understanding Coverage Needs

Every family has different needs. A life insurance agent or financial advisor can help you look at your financial obligations, sources of income, and savings and help you find the right policy. Additionally, some online calculators also can help you. It should be mentioned, however, that sitting down with an insurance professional can mean expert advice. 

A general rule of thumb to get a rough idea of the ideal amount of coverage would be to calculate the total income that would need to be replaced upon your death to help pay for your family’s financial needs. Don’t forget to consider ongoing expenses (like daycare, tuition, rent, or mortgage), immediate expenses (medical bills, burial costs, and estate taxes), and long-term financial goals (savings for college education and retirement). Your family also may need a reserve to pay for relocation or to cover expenses during a period of unemployment.

While it’s best to put in the time to understand your coverage needs, it might be helpful to keep a parameter in mind. Experts suggest that a policy should pay a benefit equal to seven to 10 times your annual income. Your needs could be higher or lower.

Types of Life Insurance

Generally speaking, when purchasing insurance, you’re going to have to review the plans on the market and determine the best type for you. Life insurance is no exception. You should begin by evaluating the ongoing and future financial needs of your family and how the policies might best suit you. Then become familiar with the various policies available and how they work. 
For example, there are two basic types of life insurance: permanent and term. Permanent insurance pays your beneficiary whenever you may die, whereas term insurance pays your beneficiary if you die during a specific period of time. 

Understanding Permanent Insurance

Permanent (cash value) insurance provides lifelong protection as long as premiums are paid. It may build up cash value over time and grows with taxes deferred. It should be noted that the cash value is different from the face amount. The face amount is the sum to be paid to your beneficiary upon your death. 

Cash value takes time to grow, but once you’ve had the policy for several years you have some options. For one, you can borrow from the insurer using your cash value as collateral. This would allow you to get a loan even if you don’t have great credit. If you don’t repay the loan, you should know that it will reduce the amount paid to your beneficiaries after your death.

Another option: You can use the cash value to pay your premiums or to buy more coverage. A third scenario involves exchanging the policy by using the cash value for an annuity that will provide a steady stream of retirement income for life or a specified period. Lat, you can cancel (surrender) the policy and receive the cash value in a lump sum. You will pay taxes on the value that exceeds what you’ve paid in premiums. 

Whole Life, Variable Life, and Universal Life

When researching your options, you might come across a few key terms. Whole life offers premiums that generally stay fixed over the life of the policy, a fixed death benefit, and cash value that grows at a fixed rate of return. Variable life allows you to choose from several types of investments offering different risks and rewards. Think stocks, bonds, combination accounts, or options that guarantee principal and interest. Death benefits and cash value will vary depending on the performance of your investments. If the market suffers, the cash value and death benefit may decrease. However, some policies guarantee that the death benefit won’t fall below a certain level. 

Universal life gives you some wiggle room in setting premium payments and the death benefit. Still, modifications must be in the purview of guidelines set by the policy. Case in point: To increase a death benefit, the insurer usually requires evidence of continued good health. A universal life policy can have a variable component.

Purchasing Life Insurance

You may be wondering how to purchase this type of insurance. You can buy such a product from an insurance agent, brokerage firm, bank, or directly from a life insurance company on the Internet, over the phone, or by mail. Most companies have websites with an overview of their offerings and some sites connect you with a local agent to expedite the process.

If you plan to go the life insurance company route, it’s recommended to research the company’s background and reputation. You can check any company’s financial condition by looking at its rating. Rating agencies evaluate the financial strength of companies. It’s worth putting in the time to ensure you don’t get scammed.

When in doubt, contact your state insurance department for a list of companies licensed in your state. From here ask friends and family for their recommendations. Ask friends and relatives for recommendations based on their own experiences. Consult with an agent or broker. Doing online research is another means to ascertain valuable information.

Bottom line: When you purchase life insurance, you help ensure the financial security of your family in the event that you pass. As of 2020, more than half of all individuals in the U.S. were covered by a life insurance policy. Will you be next?