Life insurance provides financial protection for your loved ones in the event of your death. While it may seem morbid to think about, having life insurance ensures your family will be provided for if you pass away prematurely. The proceeds from a life insurance policy can be used to cover final expenses, pay off debts, fund college savings for children, and help your spouse maintain their standard of living.
This article will provide an overview of the different types of life insurance policies available, how much coverage you likely need based on your financial situation, tips for getting life insurance at a reasonable price, how to choose the right beneficiaries, tax implications, what to do with your policy when leaving a job, when you should review your existing coverage, how to file a claim, and alternatives to traditional life insurance.
While it’s not fun to think about, having life insurance brings peace of mind knowing your family will be financially secure. This guide will provide the key information you need to make smart decisions to protect your loved ones.
Term Life Insurance
Term life insurance provides coverage for a specific period of time, such as 10, 20, or 30 years. It pays out a death benefit if you die during the term, but has no cash value if the term expires and you are still living. Term life is pure insurance protection for the lowest cost. Since the death benefit remains level during the term, it works well when you need a high amount of coverage for a short period of time, such as providing for your family until kids are grown or a mortgage is paid off.
Whole Life Insurance
With whole life insurance, you pay premiums that cover the cost of insurance and create a cash value that grows over time. The policy builds cash value which you can borrow against or withdraw. Whole life insurance stays in effect for your entire life as long as you keep paying the premiums. The premiums are guaranteed not to increase, and the death benefit does not decrease with age. It can be a good option if you want lifelong protection combined with a savings element.
Universal Life Insurance
Universal life insurance offers permanent coverage like whole life, but with more flexibility. You can adjust the death benefit and make changes to premium payments after the initial purchase. The premiums go into an account that earns interest, from which costs for the insurance and other fees are deducted. This gives you flexibility over the savings and insurance elements. Typically there is a guaranteed minimum interest rate and a cap on what the insurance company will credit to your account.
Variable Life Insurance
With variable life insurance, you can invest the cash value portion in investment subaccounts. This gives you control over how the cash value account is invested, choosing from a selection of stocks, bonds, or money market accounts offered by the insurance company. The return is not guaranteed – your cash value and death benefit can go up or down based on investment performance. Variable life is considered a security and involves more risk.
The main differences lie in whether coverage is temporary or permanent if there is a cash value that accumulates, the level of premium flexibility, and how cash value growth is determined. There are also variations like indexed universal life insurance which links cash value to a market index. Consulting with a financial advisor can help determine what type of policy aligns with your budget and goals.
How Much Coverage Do You Need?
Determining how much life insurance coverage you need can be tricky. The amount will depend on your unique situation, including your income, dependents, debts, and final expenses.
Factors to Consider
- **Income** – Consider how much income you earn now and how much your family would need to maintain their current lifestyle if you were to pass away. Often 10-20 times your annual income is recommended for coverage.
- **Dependents** – If you have children or others who depend on your income, calculate how much money they would need until they are independent. Also, factor in childcare costs like daycare or babysitting if you have young kids.
- **Debts** – Tally up debts that would need to be paid off like your mortgage, car loans, student loans, credit cards, and personal loans. You’ll want enough coverage so these could be paid off.
- **Final expenses** – Funeral and burial costs can easily be $10,000 or more. Factor this in so your family is not stuck with the bill.
Consider working with a financial advisor to run the numbers and determine an appropriate amount of coverage based on your unique financial situation and future goals. An independent advisor can provide an objective outside perspective.
Getting Life Insurance
Getting life insurance can seem daunting, but breaking it down into a few key steps makes the process much more manageable. Here’s what to expect when applying for a life insurance policy:
Health Evaluation
The first step is a health evaluation, which will require completing a medical history questionnaire and possibly undergoing a medical exam. This allows the insurance company to assess your health risks and determine the appropriate premium to charge.
The exam is conducted by a paramedical professional and usually includes a blood pressure check, blood draw, and urine sample. Your height, weight, and other vital signs will be measured. The examiner will listen to your heart and lungs and check your abdomen.
The insurance company uses this health information, along with your age and family history, to place you into a risk class that determines your premium amount. Health issues like high cholesterol, diabetes, or heart disease can increase premiums.
Policy Options
Next, you’ll choose the type of life insurance that meets your needs and budget. Term life is the most affordable and provides coverage for a set period like 10 or 20 years. Permanent life insurance covers you for life as long as premiums are paid. It builds cash value that can be borrowed against if needed.
The amount of coverage you need will depend on factors like your income, debts, number of dependents, and goals. Getting quotes for different policy types and amounts is key to finding the right fit. An insurance agent can explain the options.
Riders
Riders are add-ons you can purchase to customize and enhance your policy. Common options include waiver of premium for disability, accidental death benefits, and living benefits for critical illness. Riders increase the premium but can provide valuable added protection.
Costs
In addition to the regular premium payment, expect to pay a one-time initial fee to the insurance company on new policies. You may also owe an annual policy fee. Factors like tobacco use, high-risk hobbies, and poor driving records can increase premiums.
Working with an independent insurance agent allows you to comparison shop multiple highly-rated insurers at once. This helps ensure you get the best life insurance rate available given your situation.
Choosing Beneficiaries
When purchasing a life insurance policy, one of the most important decisions is choosing your beneficiaries. Your beneficiaries are the individuals or entities that will receive the death benefit payout from your life insurance policy after you pass away. There are a few key things to keep in mind when selecting beneficiaries:
Primary vs. Contingent Beneficiaries
You will designate primary beneficiaries and can also assign contingent beneficiaries. Primary beneficiaries are the first in line to receive policy proceeds. If one of your primary beneficiaries dies before you, their share is distributed among the remaining primary beneficiaries.
Contingent beneficiaries only receive proceeds if none of the primary beneficiaries are alive at the time of your death. It’s a good idea to name both primary and contingent beneficiaries so your policy payout is distributed how you intend.
Naming Minor Children
If you name minor children as beneficiaries, the insurance company cannot legally pay them directly. You will need to designate a custodian for the funds through your state’s Uniform Transfers to Minors Act (UTMA) or Uniform Gifts to Minors Act (UGMA). An alternative is to set up a trust for the minors and name the trust as beneficiary.
Naming a Trust as Beneficiary
Naming a trust as your beneficiary keeps the life insurance payout private, avoids probate, and allows you to provide detailed instructions on how proceeds are managed and distributed. If the trust is already established at the time of your death, the funds can be paid directly into the trust.
When setting up beneficiaries, it’s wise to consult an attorney or financial advisor to ensure your policy beneficiaries and estate planning goals align. Carefully choosing beneficiaries helps ensure loved ones are provided for how you intended.
Tax Implications
Life insurance benefits paid out to your beneficiaries are generally not subject to income tax. This makes life insurance proceeds especially valuable to your beneficiaries, as other sources of income may be taxable.
The premiums you pay for life insurance coverage are also not tax deductible.
Life insurance is considered a transfer of wealth, so the death benefit payout is not considered taxable income for your beneficiaries. The proceeds can be used completely tax-free. This differs from other assets like stocks, bonds, or property that may have capital gains taxes applied.
The tax-free nature of life insurance proceeds makes it a strategic part of estate planning. Life insurance can provide liquidity when taxes or debts need to be paid on the rest of the estate. Or, proceeds can be used to equalize inheritances if other assets will have taxes applied. Life insurance avoids the burden of taxes so your beneficiaries get the most out of the death benefit.
Policy Options When Leaving a Job
When you leave a job, you have a few options for handling your employer-sponsored life insurance policy:
- **Converting** – You may be able to convert your group policy into an individual policy. This allows you to maintain your current coverage and rates. However, you’ll lose any group discounts. Converted policies also require you to show proof of insurability.
- **Porting** – Porting transfers your current coverage into a new group plan, usually through your new employer. This option allows you to keep your rates and avoid underwriting. But porting is only available if your new employer offers group coverage.
- **Keeping** – You may be able to keep your current policy intact. This depends on the plan’s portability provision. It allows you to continue the policy with direct payments to the insurer. Premiums will likely increase though without the employer subsidy.
Consult with your insurer or HR department to understand all of your choices. You don’t want to lose coverage during a job transition. Act quickly, as you usually only have 30-60 days to exercise conversion or portability options after leaving your employer.
Reviewing Your Policy Regularly
Life happens. As your life circumstances change, it’s crucial to periodically review your life insurance policy to ensure you continue to have adequate coverage. Here are some key times in life when reviewing your policy is especially important:
- Divorce may mean you no longer need coverage for your ex-spouse. Evaluate how your relationship status impacts your ideal coverage.
- – **When you have or adopt children** – Welcoming children into your family is a big financial responsibility. Consider increasing your life insurance to cover costs like childcare, education, medical expenses, etc. if something were to happen to you.
- – **When you buy a house** – Purchasing a home often comes with a hefty mortgage. Make sure your life insurance death benefit is sufficient to pay off your mortgage and other housing expenses if you pass away prematurely.
- – **When your income changes** – Income fluctuations can impact the amount of life insurance you need. Getting a raise or promotion may mean you need extra coverage. Losing your job may warrant reducing unnecessary costs. Re-evaluate based on your current earnings.
Regularly reviewing your policy prevents being over or under-insured as your needs evolve. An independent insurance agent can help re-assess appropriate coverage at major life milestones. Keeping your policy up-to-date provides essential peace of mind.
Filing a Claim
Filing a life insurance claim can be an emotionally difficult process, but understanding the steps and documents needed can make it easier. Here is an overview of what to expect when filing a claim:
The Claim Process
- – Notify the insurance company – The first step is contacting the insurance company and notifying them of the death. Many providers have dedicated claims departments you can call.
- – Receive claim forms – The insurance company will mail or email you the specific claim forms to be completed. These forms confirm the identity of the deceased and your authority to file the claim.
- – Provide proof of death – You will need to submit an official death certificate, which can be obtained from the funeral home or county records office. This verifies the insured’s passing.
- – Submit policy documents – Locate the original policy documents, if you have them, and submit to the insurance company. This helps verify coverage amounts and beneficiaries.
- – Supply additional information – The insurance company may request additional documents like medical records, depending on the policy type. Provide any information they require in a timely manner.
- – Process and review – The insurance company will review all documentation and process the claim. This can take 30-90 days depending on complexity.
- – Receive payment – Once approved, the death benefit will be paid out to the designated beneficiaries according to the policy terms. You may elect to receive it as a lump sum or in installments.
Documents Needed
Here are some of the key documents you’ll need to file a successful claim:
- – Death certificate
- – Policy documents like the declaration page
- – Beneficiary designation forms or estate documents
- – Medical records or physician’s statement if required
- – Your photo ID, contact, and banking details
- – Claim forms provided by the insurance company
- The claims process can feel overwhelming, but insurance companies have dedicated teams to help guide you through each step. Don’t hesitate to contact them with any questions along the way.
Alternatives to Traditional Life Insurance
Life insurance policies provide financial protection for your loved ones. But traditional life insurance may not be the right solution for everyone. Here are some alternatives to consider:
Annuities
Annuities are insurance products that provide guaranteed income for a set period of time or for life. With a fixed annuity, you pay a lump sum or series of payments to an insurance company. In return, they provide a fixed stream of income in the future.
Annuities can supplement or even replace life insurance. The income continues even after you pass away. Your heirs would miss out on a death benefit payout, but they’d continue receiving income from the annuity.
There are also variable annuities. Your money goes into investment subaccounts, so your income payments can fluctuate based on market performance. Variable annuities carry more risk but potentially higher payouts.
Self-Insurance
Some people “self-insure” by setting aside savings to provide for their families. This may be an option if you already have significant assets or income streams that won’t cease at death.
For example, you might have rental properties, dividends from a large investment portfolio, company ownership stakes, etc. Your heirs can inherit these assets and continue earning the associated income.
Self-insurance requires financial discipline – regularly setting aside funds for your family’s protection. As an alternative to life insurance, it also requires a high net worth. For most people, life insurance is more cost-effective.
Final Expenses Insurance
Final expense or burial insurance provides a small death benefit – typically only a few thousand dollars. It covers “last expenses” like your funeral, burial costs, and any outstanding small debts.
This very minimal life insurance may work if you have no dependents but want to spare your family from final expenses. It’s an affordable way to cover costs they’d otherwise inherit.
The key is carefully weighing alternatives against your family’s needs and resources. An insurance agent or financial advisor can help analyze the options. The right life insurance product can give your loved ones long-term financial security.