A nationwide study on life insurance recently completed by Forbes Learnvest revealed that showed 57% of respondents owned life insurance. Good news right, however only 28% were “extremely confident” about their understanding of their coverage or how life insurance works. 66% of study respondents had a poor understanding of how they would access their money when their loved ones die. A little side note, the insurance company would probably appreciate you not knowing how to access the money as well.
So let’s get down to the basics here. Life insurance is a policy that will pay money to a named beneficiary when you pass. This is a vehicle to help protect your loved ones if you were to die before you got old. In most cases it provides cash to pay for your family to keep on living if one or both of the parents die while they are still raising children. It could also be good to have if you are going to protect your loved ones from your financial obligations When you purchase the policy, you determine the amount of coverage you need. There are many types of life insurance available, let’s explore a few of them them here.
If you ask a nail maker if you need nails, they’ll give you a hundred reasons why you need nails. The same thing goes for life insurance salespeople. You want to make sure your family is protected. What if I don’t have a family? You will never get it cheaper than if you buy it today, you may fall in love tomorrow and regret not buying it today. Do I need permanent insurance or just term? C’mon, you don’t want to temporarily protect your family do you? They sell and they make money when you buy, that’s always something to remember!
In my opinion there is really one reason you are going to need life insurance. The first and biggest, you have a family that is dependent on your resources for their well being and survival. This is the most common time to think about life insurance. You know the kids are going to be dependent upon your financial well being for at least 20 years and you want to hedge against something happening to you. An easy rule of thumb is you get enough that your family could live off the interest for a good period of time and they’ll also be able to pay off any debts you may have incurred. However I think something important to see here, it’s really if you have people financially dependent on you. If you don’t, don’t buy! Remember the nail maker!
Universal life sounds like a church you may want to warn your friends about if they are going to join! In all seriousness, there are a few different types of life insurance policies in the market and the easiest way to distinguish b/w them is temporary vs permanent. Let’s get into those differences now.
Term insurance is the least expensive plan you will find on the open market. There are typically 2 ways you can buy term insurance. One is through your employer if it’s part of the benefits package. This will typically not be a large policy, but often the employer will allow 2-5 times your annual income and it’s very inexpensive. If you have a need, this will get you part of the way there, very cheap! The other way is to buy a 10, 20 or 30 year policy on the open market. These policies, while not as cheap as your employers, are the least expensive manner in which to protect your family for financial loss if you die. Let’s give a scenario to explain how this works.
First, an understanding of how Life Insurance companies decide how much they collect from you each month in exchange for how much your family gets if you die. Remember, this could mess with your head a bit, but this is money you will NEVER see, but you are buying so those around you don’t suffer. Now to the meat and potatoes. Your monthly premiums are what you pay to insure the company pays if you die. These rates with life insurance are typically based on your present age today, your health, your family history, whether or not you smoke or work in a dangerous industry or spend your spare time jumping out of airplanes and shooting off fireworks. If you do the latter, you will probably not get the policy!
The gist here, the younger and healthier you are, the lower your risk is to the insurance company that you are going to die within the term of the policy and thus the less money you have to pay in insurance premiums. The opposite is also a factor. Let’s say Sarah is a 26 year old girl who works out, doesn’t smoke and eats food from Whole Foods everyday. She’s a much lower risk than John who is 45, hasn’t exercised in 5 years and lives on a steady diet of Cheetos and Bud Light. Who do you think is going to have more healthy years ahead. Just don’t ask my dad because he’d swear that John will outlive Sarah!
When you buy term insurance, you are buying a set amount of time to insure yourself, at a specific amount of money, say $300,000 to $2,000,000 and it’s typically 10-30 years. This is the most basic type of life insurance and the easiest to understand. It’s very straightforward and unless you are working with a financial professional who has a deep understanding of overfunding insurance products for cash value pull outs, this is really the only type of life insurance you’ll need over time. You die, family gets paid, you live, family keeps you!
Whole life is a policy that does what it says, it’s going to protect you for your whole life. The insurance company set’s a premium knowing that as long as you pay, they are going to have to pay out sometime. It could be today, it could be in 50 years. That said, they know they will have to pay and they set your premiums to reflect that. That’s why whole life is so much more expensive than term. The insurance company is placing a bet they only imagine they will lose, so they need to find a way to profit!
A few notes here about Whole Life Insurance. These policies are also unique in that they allow you to borrow, tax-free, against the policy’s cash value during your lifetime. Of course, the policy’s cash value changes over time and is lower than the total sum of the death benefit it provides. So, how exactly does cash value accumulate in your permanent life insurance policy?
According to our friends at investopedia “When you make premium payments on a cash-value life insurance policy, one portion of the payment is allotted to the policy’s death benefit (based on your age, your health, and other underwriting factors). The second portion covers the insurance company’s operating costs and profits. The rest of the premium payment will go toward your policy’s cash value. The life insurance company generally invests this money in a conservative-yield investment. As you continue to pay premiums on the policy and earn more interest, the cash value grows over the years.”
They also go on to explain that in the early years, the cost of insuring you is lower so more of your cash value goes into the permanent cash feature. Then as you get older, more of the premium is going to pay for the insurance.
With whole life, you are buying consistency. This is something to consider. You may get a set interest rate on your cash value, which would be great in times of higher rates. You get a set death benefit amount that doesn’t change and you get that word guaranteed built into your policy. Another benefit is if your financial situation changes you have the ability to use your cash value to pay your premiums for you, although your payout will be lower, the protection is a cool feature.
Universal Life is the final type of policy we’ll address here. We could go into Variable Universal policies, but these subaccounts are associated with the stock market and personally, I’m not a financial advisor, so I’d prefer you speak to an advisor about these policies! Universal policies are similar to Whole Life policies in they are permanent protection, however they offer some flexibility. The good is the flexibility in both premium, cash value and face value, the bad, you need to pay attention to these policies, their changes and values over time. It’s not a plan for a set it and forget purchase, but if you put the work in, you could save over whole life insurance over time.
There are multiple types of Universal policies on the market today and most of them are relatively complex. If you are interested in a Universal policy, I’d recommend working with a fee based advisor that doesn’t work on commissions and has the ability to put your interest first. Remember, anyone that works on commission wants to sell a higher amount, it’s the nail maker and the nails! Our typical rule of thumb is buy term and invest the rest. There are myriad investment schemes out there today that could be very beneficial for you.
Life Insurance plans also offer a series of optional add ons known as riders. Here are a few of them to consider when looking at your policy. Critical Illness and Chronic Illness riders are there to pay money if you get a critical illness or a chronic illness. The critical illness rider is typically set amount of money for cancer, heart disease etc… The chronic illness rider allows you to access your policy amount if a physician says you have 12 months to live or less. Other riders i
nclude Accidental Death or Double indemnity if you die in an accident. This basically means if you die with a certain accident or an accident period, your family gets much more money. There are riders for spouses (insure your spouse), waiver of premium (if you are disabled and can’t work, the premiums are waived), Child term rider (insure your child) and Long Term Care riders (this is probably the most valuable of the riders). This rider states that if you cannot do 2 activities of daily living, such as cleaning, using the restroom, moving yourself around, cooking for yourself etc., the policy will allow you to use your benefit amount to pay for someone to do these things for you. It’s an expensive rider and a type of policy we’ll dig into in a later article, but it’s a great way to protect yourself against a long term care need.
Remember, we here at How To Be Grown believe in the comparison model for buying insurance and Policy Genius has perfected this model. Please click on the link below and shop their preferred carriers. We believe you won’t regret it! If you have any questions, as always, don’t hesitate to email me at firstname.lastname@example.org I’m happy to provide guidance, advice and as always recommendations on how to be grown!