Fundamental Friday -- Life Insurance
Life insurance offers a way to replace the loss of income that occurs when someone dies. This person is usually the one who produces the majority of income in a family situation. It is a contract between an individual as the insured person and the company or “carrier” providing insurance. A good life insurance program does more than just replace the loss of income that occurs if the insured dies.
It should also provide money to cover the new costs that arise after the insured’s death such as funeral expenses, taxes, probate cost, the need for housekeepers and child care, and so on. An individual may consider insuring the life of a spouse who is not earning money.
Life insurance can be a unique wealth creation tool that assures the accumulation of a desired amount of liquid capital at death among other things. Depending on the plan of insurance, it may also create more or less capital for lifetime needs.
Life insurance costs vary based on the age and health habits of the policy owner and the amount of insurance. A life insurance policy may afford greater indemnity when the death is accidental. When twice the face amount of the policy is paid upon death occurring accidentally, such coverage popularly is known as “double indemnity.”
The Basic Definition of Life Insurance
A working definition of life insurance begins with understanding why the concept of insurance originally developed. In all lives, uncertainty exists about what will happen tomorrow, next month, next year. The future holds unknown events, some will be positive, others, negative. Negative events include the possibility of loss. Insurance is specifically concerned with financial loss.
Because most people own and rely upon the availability of cars, they can envision the financial loss that will occur if the car is damaged in an accident. As a result, people buy auto insurance to protect themselves against the uncertainty—the risk they take by driving—that they will suffer a financial loss if an accident occurs.
The Design of Life Insurance
Life insurance is designed to protect against the risk of death. The risk of death exposes a family or a business to certain financial risks such as burial expenses, paying off debts, loss of family income and/or business profits. There are different types of life policies, as noted below. An individual has the opportunity to shop all the best insurance companies to give him or her, the maximum coverage at the lowest rate. This is not the only item about life insurance that is important, however. It is of utmost importance for an individual to evaluate his or her particular circumstances in life. Some of the things that must be considered are what exactly he or she is planning for; whether he or she is in the middle of raising a family or if they are still in college about to marry.
On the other hand an individual may be mid-40s or mid 50s when he or she decides to invest in life insurance. The needs at that time would be considerably different.
Other Purposes of Life Insurance
Paying Death Benefits
The best understood and most obvious purpose of life insurance is to pay a certain amount of money to survivors when the insured person dies. Paying death benefits was the original purpose of life insurance policies and continues to be the major reason people buy life insurance. Life insurance paid at the time of death can be used for many purposes, including:
· Ongoing living expenses for survivors;
· Retiring a mortgage on the survivors’ home;
· Establish a fund for children’s future college costs;
· Paying off debts existing when the insured person dies;
· Paying death expenses, such as medical and funeral costs;
· Buying out a surviving partner’s interest in a business;
· Replacing income lost by the death of a key employee.
While life insurance has traditionally been used for purposes such as these, contemporary policies can provide additional benefits, whether the insured person lives or dies.
Cash Accumulation
As life insurance policies evolved, more emphasis was placed on the cash values that accumulated in policies as premiums were paid. Certain policies have features allowing cash accumulation that may be used by the insured person who does not die. For example, a policy might accumulate cash values that would be payable to the policy owner when she or he reaches a certain age or after the policy has been in force for a specified number of years.
An insurance policy builds guaranteed or non-guaranteed cash value depending on the type of life insurance that an individual owns. This cash value builds as the policy owner pays premiums when due. These values are further enhanced since taxes on the money's growth are deferred. This cash value can be accessed through a valuable loan provision.
The policy owner can borrow from their policy’s accumulated cash value by taking a loan at competitive interest rates. The policy owner can use these funds any way he or she wishes such as making a down payment on a home, finance a new car, or even start a business. The loan privilege is a valuable feature of permanent life insurance, but the policy owner must keep in mind that borrowing against the policy’s value does reduce the insurance protection.
Estate Building or Conservation
A life insurance policy can provide substantially for the income needs of surviving dependent family members. Whether this is children left behind or a spouse, there will be a need for a cash stabilization. Another benefit of a life insurance policy is to pay federal and state death taxes and other estate settlement costs. It can be used to pay debts, to provide for children’s education or to meet “special” financial demands of physically or mentally handicapped or learning-disabled children or parents or other dependents with physical or mental limitations.
Another principal use of life insurance is to shift wealth from one generation to another in the most cost effective manner possible or to relieve survivors of financial management burdens by providing an inexhaustible lifetime annuity. Life insurance policies can create an instant estate to benefit a charity.
Making a financial gift to a favorite charity is a goal shared by many people. A substantial gift may seem to be out of reach, but a policy owner will be able to do just that through the use of discounted dollars to make this happen. This is an overview of the many areas a life insurance policy can be used and can make the lives of many people a little more cushioned.
Fundamentals of Life Insurance Purpose
Life insurance’s main use is to protect a dependent or a family from the premature death of the breadwinner. With the principal reason for a young or middle-aged person to purchase life insurance being to pay a benefit upon the death of the insured person, the insured individual who has a spouse and children who depend on his or her income may need to consider other situations in his or her life in need of security. If there are business associates who depend on a key person for the operation of the company, the firm may need to insure his or her life for the future of the business.
The last thing a family or business associates needs to worry about is coping with the financial consequences of an untimely death. Without the breadwinner in a family, a family may not be able to meet mortgage payments, provide for college, or prepare for retirement. Immediate and future family needs may be put on hold as a result of death whether untimely or not, just as business operations could be turned upside down.
Life insurance basically comes in two forms. One type pays only a death benefit--a specified sum of money--to the person or persons designated, if death occurs within a specified period of time, or “term.” This is an immediate benefit on the occasion of death and for a certain amount of years after death. The other, more permanent type, comes with an additional feature that builds tax-deferred savings called “cash value.”
Death Benefits
When traditional types of life insurance are written with a certain death benefit – let’s say $100,000 – the face amount of the policy remains in effect as long as the policy owner pays the premium, but if no premium is paid, the insurance can terminate. One important feature of some life insurance policies is the death benefit is adjustable – it could be $100,000 at the beginning of the policy period, but it might drop down to $50,000 at some point and later rise to $175,000. Within certain limitations, the policy owner controls these adjustments.
On the other hand, insurers do not typically allow policy owners to raise the death benefit in lieu of paying a lower premium because this action would put the insurer in the position of providing greater coverage without evidence that the insured’s health has remained stable.
Replacement Income
A life insurance policy can replace income for the survivors during a period of readjustment period of two or three years after the policy owner’s death. If the family is a two-income family, it takes time to adjust to one paycheck instead of two. If the policy owner is the sole wage earner, with young children at home, the spouse’s need for a readjustment period is obvious.
· The period while children under age 18;
· The college years;
· The years preceding retirement for the surviving spouse;
· The period after retirement.
In general, determining how much life insurance an individual needs means deducting the sum total of the income that would be lost upon the insured’s death from the sum total of your family’s ongoing financial need. It also means calculating the impact of inflation and building in enough “extra” to counteract inflation’s effects.
Mortgage Loans
When two of the most often used financial tools - the cash value life insurance policy and the home mortgage are combined, home buyers can get life insurance with their mortgage loan. This involves a life insurance policy for free, death benefits that allows an individual to leave his or her home to loved ones debt free and besides earn money with the mortgage payment for retirement and paying off a home.
The principal amount of the loan does not decrease with each mortgage payment. In fact, the money paid each month is never applied to the principal. That money is used for the life insurance aspect of the program. The money that would normally be used to reduce the principal is, instead, allocated to a special universal life insurance policy that builds cash value on a tax-deferred basis for the borrower with every payment.
Cash Accumulation
At the end of the term, there is enough cash value accumulated in the fund to pay off the loan, plus provide a substantial cash payment or income stream to the borrower. The monthly payment on $250,000 with a 30 year, fixed 8% rate loan would be $1,834. Under some programs the payment could be $2,045, an increase of $211. But what about the life insurance aspect? A homeowner could purchase a separate term or whole life insurance policy independently from another insurance agency. The cost will vary depending on the applicant's age and health. The death benefit from an independent policy can then be used by the home owner's surviving dependents to pay off the home.
One of the potential benefits of some life insurance programs with home mortgage is the non-declining interest. This means homeowners would be able to deduct the maximum amount of interest each year on their taxes. This is only a benefit provided the individual itemizes their deductions. If they do not, the constant interest charges would not be a benefit.
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