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Life Insurance
What Is Life Insurance?
Life insurance is a contract between an insurer and a policy owner. A life insurance policy guarantees the insurer pays a sum of money to named beneficiaries when the insured dies in exchange for the premiums paid by the policyholder during their lifetime.
Like other insurance options, life insurance is a useful tool to provide financial support for your loved ones.
Benefits of Life Insurance
Most people use life insurance to provide money to beneficiaries who would suffer a financial hardship upon the insured’s death. However, for wealthy individuals, the tax advantages of life insurance, including the tax-deferred growth of cash value, tax-free dividends, and tax-free death benefits, can provide additional strategic opportunities.
The death benefit of a life insurance policy is usually tax-free. Wealthy individuals sometimes buy permanent life insurance within a trust to help pay the estate taxes that will be due upon their death. This strategy helps to preserve the value of the estate for their heirs. Tax avoidance is a law-abiding strategy for minimizing one’s tax liability and should not be confused with tax evasion, which is illegal.
Types of Life Insurance
Many different types of life insurance are available to meet all sorts of needs and preferences. Depending on the short- or long-term needs of the person to be insured, the major choice of whether to select temporary or permanent life insurance is important to consider.
Term vs. Permanent Life Insurance
Term life insurance differs from permanent life insurance in several ways but tends to best meet the needs of most people. Term life insurance only lasts for a set period of time and pays a death benefit should the policyholder die before the term has expired. Permanent life insurance stays in effect as long as the policyholder pays the premium. Another key difference involves premiums—term life is generally much less expensive compared to permanent life because it does not involve building a cash value.
Before you apply for life insurance, you should analyze your financial situation and determine how much money would be required to maintain your beneficiaries’ standard of living or meet the need for which you’re purchasing a policy.
Term Life Insurance
Term life insurance lasts a certain number of years, then ends. You choose the term when you take out the policy. Common terms are 10, 20, or 30 years. The best term life insurance policies balance affordability with long-term financial strength.
- Decreasing Term Life Insurance – decreasing term is renewable term life insurance with coverage decreasing over the life of the policy at a predetermined rate.
- Convertible Term Life Insurance – convertible term life insurance allows policyholders to convert a term policy to permanent insurance.
- Renewable Term Life Insurance – a yearly renewable term life policy provides a quote for the year the policy is purchased. Premiums increase annually, but renewable term is usually the least expensive term insurance in the beginning.
Permanent Life Insurance
Permanent life insurance stays in force for the insured’s entire life unless the policyholder stops paying the premiums or surrenders the policy. It’s typically more expensive than term.
- Whole Life – whole life insurance is a type of permanent life insurance that accumulates cash value. Cash-value life insurance allows the policyholder to use the cash value for many purposes, such as a source of loans or cash or to pay policy premiums.
- Universal Life – a type of permanent life insurance with a cash value component that earns interest, universal life features flexible premiums. Unlike term and whole life, the premiums can be adjusted over time and can be designed with a level death benefit or an increasing death benefit.
- Indexed Universal – this is a type of universal life insurance that lets the policyholder earn a fixed or equity-indexed rate of return on the cash value component.
- Variable Universal – with variable universal life insurance, the policyholder is allowed to invest the policy’s cash value in an available separate account. It also has flexible premiums and can be designed with a level death benefit or an increasing death benefit.
Burial or final expense insurance is a type of permanent life insurance that has a small death benefit. Despite the names, beneficiaries can use the death benefit as they wish.
What Affects Your Life Insurance Premiums and Costs?
Age
This is the most important factor because life expectancy is the biggest determinant of risk for the insurance company.
Gender
Because women statistically live longer, they generally pay lower rates than a male of the same age.
Smoking
A person who smokes is at risk for many health issues that could shorten life and increase risk-based premiums.
Health
Medical exams for most policies include screening for health conditions like heart disease, diabetes and cancer, and related medical metrics that can indicate risk.
Lifestyle
Dangerous lifestyles can make premiums much more expensive.
Family Medical History
Evidence of major disease in the immediate family makes the risk of developing certain conditions much higher.
Driving Record
A history of moving violations or drunk driving can dramatically increase the cost of insurance premiums.