What is life insurance?
Life insurance is an agreement
between you (the insured) and an insurance company (the
insurer). Under the terms of a life insurance contract,
the insurer promises to pay a certain sum to someone (a
beneficiary) when you die, in exchange for your premium
payments.
Why would you need life insurance?
The most common reason for buying life insurance is to
replace the income lost when you die. For example, say
that you work, and your income is used to support yourself
and your family. When you die, and your paychecks stop,
the life insurance proceeds can be used to continue to
support the family members you've left behind.
Another common use of life insurance
proceeds is to pay off any debts you leave behind. For
example, mortgages, car loans, medical bills, and credit
card debts are often left unpaid when someone dies. These
obligations must be paid from the assets left behind. This
can deplete the resources that your family needs. Life
insurance can be used to pay off these debts, leaving your
other assets intact for your family to use.
Life insurance provides liquidity to
your estate. When you die, you may leave some liquid
assets (such as cash, CDs, and savings bonds), and some
illiquid assets (such as real estate, an automobile, and
stocks). Your liquid assets may not be enough to pay all
the debts that you leave behind, plus all the expenses
that arise because of your death (such as funeral expenses
and estate taxes). Your illiquid assets may have to be
sold in order to meet these obligations when they come
due. This may cause a financial loss if the assets must be
sold cheaply in order to get the money on time. Life
insurance can avert this situation, because the proceeds
are available almost immediately upon your death.
Life insurance creates an estate for
your heirs. After your debts and expenses are paid, there
may not be much left over for your family. Life insurance
can automatically provide assets for them after your
death.
Life insurance is also a great way to
give to charity when you die. You may have always had a
great philanthropic desire, but not the means to make it a
reality. Life insurance can do that for you.
Life insurance can even be a key element
for specialized business applications, such as funding a
buy-sell agreement. Under a buy-sell agreement, life
insurance can be used to provide cash for the purchase of
a deceased owner's interest in the business.
Finally, life insurance can be an
investment vehicle. Some types of life insurance policies
may actually make money for you, as well as provide the
benefits described above. This can help you with long-term
financial goals and strategies.
What do you need to know about life
insurance?
There are several kinds of policies that may be
available to you.
Term life insurance policies provide
life insurance protection for a specific period of time or
term. If you die during the coverage period, the
beneficiary named in your policy receives the policy death
benefit. If you don't die during the term, your
beneficiary receives nothing. Common term policies
last for 10, 15, 20 and even 30 years.
Permanent insurance policies provide
insurance protection for your entire life as long as the
policy remains in force. In addition to the insurance
protection provided, this type of policy also builds
internal cash values, often described as a savings account
within the policy.
Below is a list of the different kinds
of permanent insurance policies:
- Whole life
- Ordinary level premium whole life
- Limited-pay whole life
- Current assumption whole life
- Variable life
- Adjustable life
- Universal life
- Variable universal life
- Joint life (first to die)
- Survivorship (second to die)
You also need to know that the cost of
life insurance will depend upon the type of policy, your
age, and your health at the point in time when the policy
is issued.
A life insurance contract is made up of
provisions, options, and riders. Provisions describe or
explain features, benefits, conditions, or requirements of
the contract. Options are features of the agreement that
require you to make a choice regarding some aspect of
coverage. Riders are additional coverage (or endorsements)
offered by the insurer at the time of application and
added to the standard agreement in return for an
additional premium.
Finally, you need to know the tax
consequences of owning life insurance.
- Life insurance premium payments are
not tax-deductible expenses.
- In general, the death benefit paid to
the beneficiary is not included in gross income for
federal income tax purposes, because it is paid with
after-tax dollars.
- You must be very careful about who
owns the policy and who the beneficiaries are, in
order to avoid estate taxes on the proceeds when you
die.