As we begin establishing our financial foundation, one of the most important things to do is put in place the proper precautions and financial securities in the event something unexpected occurs. This most prominently takes the form of insurance, a safety net that can provide financial support for the snags we hit. The only problem is that for those with little knowledge about finances and insurance, there are often many questions that arise. Moreover, with so many forms of insurance, it may not always be obvious how people should allocate their money to protect themselves. To aid in that effort, this is a beginner’s guide to life insurance that should provide a basic understanding of what life insurance is and how it can be used to achieve personal financial goals.
What is Life Insurance
Life Insurance is a contract made between an individual and an insurance company that requires individuals make regular payments, or premiums, in exchange for a lump-sum payment that is made upon their death. This payment is known as a death benefit and it is given to pre-specified persons known as beneficiaries. The complexity of life insurance policies can vary from plan to plan as different types of policies and features can be included within them. Therefore, this article explains the different types of life insurance under the basic Life Insurance and Complex Life Insurance group.
1. Term Life Insurance
Term life insurance is one plan meant to provide coverage for a specified time, for example, ten years. When it comes to the premium, a traditional life insurance policy usually remains fixed at the same rate for the specified time. If the person outlives the term, then premiums tend to go up. There is something known as a return of premium rider feature that can be included in plans stipulating that in the event you do not die during the period you were paying for coverage then you will receive some of, or possibly all of the money you put to the cost of insurance. In terms of cost, term life insurance is usually not as expensive as other plans and premiums are priced based on the likelihood someone will pass within the term.
Something to note about term life insurance is that payment to beneficiaries does not occur over a stretch of time and instead is given as a single lump sum payout.
When it comes to term life insurance, there are some add-ons you may want to consider including with your plan to make it as valuable possible. Two important ones include guaranteed renewal term policies and decreasing term policies.
1.1 Guaranteed Renewal Term Policies
Guaranteed renewal term policies ensure that when the end of your term life insurance comes, even in the event your health has begun to decline, you can still renew the policy for an additional term. This is helpful as it works as a guarantee that no matter your condition, you are still able to reestablish your policy and ensure there is something left for your beneficiaries.
1.2 Decreasing Term Policies
As the name suggests, the decreasing term policy reduces the amount of the death benefit on an annual basis. While this may seem like something undesirable, as the total of the death benefit decreases, so too does the expense of the policy, offsetting the amount that does not end up getting paid out to beneficiaries. Initially, the monthly premium will likely stay fixed, but after that they too will begin to decrease as well.
2. Permanent Life Insurance
Permanent life insurance, like term life insurance, determines the amount paid with each premium based upon the probability that someone passes away. The difference, however, is that unlike term life insurance, permanent does not expire. In addition to the amount paid out in the form of the death benefit, permanent life insurance has a saving component known as a cash value that can be tapped by users while they are still living and be put towards major expenses. Permanent life insurance policies also come with maturity dates, the age in which the amount of savings in the plan is equal to the death benefit. Usually, this isn’t until a far-off time, as some plans have a maturity date of that coincides with someone turning 100 years old while others are making the date even further off than that. While some permanent insurance life policies require the premium to be paid up until the maturity date, others only require that it be paid until a certain age. In looking at permanent life insurance, there are three main types which are whole life, variable life, and universal life.
2.1 Whole Life
The way that the cash value in a whole life policy grows is based on a formula utilized by insurance companies. As the cash value grows, the formula holds its increase at a steady rate. This rate remains fixed, as the formula does not change over the life of the plan unless certain actions are taken. These actions can include withdrawing a portion of the cash value or surrendering the policy altogether.
2.2 Variable Life
The cash value of a variable life policy is not guaranteed, as there exists the possibility of growing it through the allocation of a piece of the premium money into investment funds held within your insurance company’s portfolio. This kind of policy entails some risk as the funds, stocks, and bonds that are included within them are subject to the volatility of the market.
2.3 Universal Life
Sharing some similarities with the variable life policy, the growth of cash value in the universal life policy is rooted in variability, as increases are based upon the performance of the certain indexes within the stock market. This policy was initially designed to act as a cheaper form of permanent life insurance but is known to include certain features that individuals considering the policy should be aware of beforehand.
When it comes to life insurance, it is important that it not be overanalysed or undervalued. Especially in the event you have someone relying on you financially, life insurance is important to have so that they have some financial protection in the event the unexpected happens. At the same time, you don’t want to pick a plan so extensive that it is difficult to afford premiums. Do your research and find the plan that works best for you as this will help to ensure you and your loved ones sustained peace of mind.
About the author
Douglas Keller has been a financial expert for 20 years, helping people reach financial stability. He now provides personal finance tips for Payless Power’s blog, where he helps people save money on their bills every month and work towards long-lasting financial health.