Life Insurance 101

by The Smarter Wallet on April 5, 2010

You’ve got your savings in a good high yield savings account and your online stock broker accounts have been doing well. But are these enough to cover the needs of your dependents when you’re no longer around?

You know you need life insurance yet you keep putting it off. Unfortunately, life insurance doesn’t typically get cheaper as you get older. Waiting and putting things off means that you could end up paying more every month for the same life insurance policy. When you figure out the basics of life insurance, you can make an educated decision based on your financial circumstances.

What Is The Purpose Of Life Insurance?

Based on the terms of your life insurance policy, its purpose is to cover expenses for your family or business associates after you die. These expenses may include health care bills, funeral fees, mortgage payments and the cost of continuing business operations without you. If you’re shopping for life insurance, here are a few resources to help you get started:

Where To Get Life Insurance

How Much Life Insurance Should You Carry?

There is a simple way to determine the amount of life insurance you need. Before you purchase a policy, you should figure out:

1. The total monetary amount of your short term needs. Short term needs include final expenses such as hospital bills, funeral costs, attorney fees, taxes, probate, outstanding debts and unforeseen expenses.

2. The total monetary amount of your long term obligations such as mortgage payments, loan repayments and college tuition.

3. The yearly cost of living to maintain your lifestyle multiplied by the years you expect to live that lifestyle (this typically includes your family’s lifestyle).

4. Add items 1, 2 and 3 then subtract that amount from your current net worth, which should include current and future payments from social security.

The number you get at the end of these calculations represents the estimated amount of life insurance you should purchase.

Determining The Length Of Your Life Insurance Policy

Determining the length of the insurance policy is another important factor. Term life insurance covers you for a specific period of time, such as 10, 20 or 30 years. Whole life insurance, also called permanent life insurance, covers the insured person for life. As a result, the premiums for whole life insurance are higher. On the other hand, whole life insurance builds cash value over the life of the policy while term insurance has no cash value at the end of the term if you are still alive. Also, the cash value of whole life insurance is tax-deferred.

Should You Buy Whole Life Insurance or Term Life Insurance?

Now that you know that there are two basic types of life insurance, let’s break them down further. There are three types of term life insurance: level, decreasing and increasing. With level premium term life insurance, the premiums are set with increases for inflation every two years. This is frequently an affordable way to get life insurance. Decreasing term life insurance is often purchased as mortgage protection insurance with the benefit decreasing along with the outstanding balance of the mortgage. For growing families that are paying down a mortgage, this is an ideal policy. Increasing term life insurance increases as you get older without ongoing proof of good health (e.g. without the need to prove that you’re in good health as you age). This is beneficial for people who may experience declining health with age and who don’t want their premiums to go up as a result.

There are also three types of whole life insurance including: single premium, survivorship and universal. Single premium life insurance is paid out in one large payment so beneficiaries can use the funds right away. Survivorship life insurance policies insure two lives to provide for the beneficiaries in any event. Universal life insurance policies allow you to change the death benefits and premiums as your beneficiary’s needs change to give families greater flexibility as their financial situation grows and changes.

Clauses To Check Out Before Your Final Decision

Before you make a final decision about life insurance, check out a few key clauses in your policy. The incontestability clause lets you know the length of time given an insurance company to question or disagree with any payouts they’re required to make against your policy. The standard time period is 2 years. The suicide clause specifies whether the policy is invalid or restricted in the event of suicide. Lapse and reinstatement clauses let you know the penalties for failure to pay premiums. “Simultaneous death of insured and beneficiary clauses” refer to rules covering the situation of who dies first and what payout is made in such circumstances.

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{ 1 comment… read it below or add one }

1 Hope to Prosper April 19, 2010 at 4:47 pm

Whole or Universal life insurance is a notoriously poorly performing investment vehicle. It often benefits insurance companies and salespeople, much more than it benefits their customers.

Another problem with these policies is that you don’t usually receive the death benefit and the so called “investment” portion. You only get one or the other. If you think your beneficiaries would receive both if you died, you would be mistaken. This rarely gets mentioned in the sales pitch.

People are usually much better off buying a less expensive term policy and investing the difference in premuim cost into another investment. That way, if the investment doesn’t perform well, you can simply move it and keep your insurance. Or, you could move your insurance and keep your investment. And, if you do unfortunately die, your beneficiaries get both the insurance and the investment.

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