Are you prepared for whatever happens next? If 2020 taught us anything it’s that you can’t be too ready. A protection plan includes a few essential elements: An emergency cushion, health insurance and – for some – a basic estate plan and enough life insurance.
The latter is something many people – especially women, who are chronically underinsured – avoid thinking about for as long as possible for reasons that are more than understandable. So, to make the question of whether you need it a little less daunting, set your emotions aside for a moment and answer this simple question: Would anyone suffer financially if you weren’t around to provide for them? That person doesn’t have to be a child, it could be a dependent parent, a spouse, even a business partner.
If the answer is yes, then you should consider buying some type of life insurance, which would provide your family or other dependents with cash (known as a “death benefit”) if you were to pass away. This could help replace your income, cover funeral costs, pay off debt, or fund college for your kids. There is also no federal income tax on life insurance benefits, unlike other types of assets that your loved ones might inherit upon your death.
Simply put: Life insurance is a smart way to ensure that others are taken care of if something were to happen to you. Read on for information to help you figure out which type of insurance makes the most sense for you.
Term Life Insurance
Term life insurance provides a death benefit for a specified amount of time (the term). And then it ends (or terminates). Because it’s just a death benefit, or a pure insurance policy without an investment component attached, it’s usually the most inexpensive form of life insurance. The cost varies based on factors like health, age (it rises as you get older), location and size of death benefit.
Term is ideal if you need coverage for a certain amount of time (e.g., until your child graduates from college or until your mortgage is paid off or until you’ve amassed enough to retire). Because prices go up as you age, people often opt for “level term” policies which hold the prices steady for up to 20 or 30 years. There aren’t any bells or whistles — if you die during the term, your designated beneficiary will collect the death benefit. If not, the policy will end once the term is over.
Employer-Sponsored Life Insurance
Many of us carry some group term life insurance coverage through our employers without even realizing it. (Check with your HR department to understand what’s available to you or your spouse. Buying through your employer may offer you a less expensive way to buy more because group life – like group health – spreads out the risk.) The downside: This type of insurance isn’t usually portable, meaning that when you leave your job, you’ll lose the coverage. And, buying more at an older age can be more costly.
Accidental death and dismemberment insurance (also known as AD&D) is another common form of employer-sponsored life insurance. While it’s not a bad safety net to have, it won’t pay out a death benefit if you pass away from illness or other non-accidental causes, unlike term insurance. If this is all your employer offers, seek out additional insurance.
Permanent Life Insurance
Permanent life insurance provides coverage for life, as long as the premiums are paid. But it doesn’t just provide a death benefit, it also has an investment component that enables you to accumulate cash value.
How does that work? A portion of your premium will go toward building cash value, which can then grow tax-deferred from policy dividends, interest or investment earnings. And you can borrow (usually tax free) or withdraw the cash value if you need it. But because it’s doing double duty, it’s often substantially more expensive than term life. And any loans or withdrawals that aren’t paid back can reduce the death benefit, possibly leaving your loved ones with less. (You’ll often have to pay a cancellation charge if you no longer want the policy.)
Ultimately, to determine whether permanent life insurance is right for you, ask yourself a couple of questions. First, what can you afford? If buying term is the only way to get enough insurance to provide for the needs of your dependents, then term is the way to go – or at least the way to start (you can often add some permanent insurance down the road by converting term life into the stuff that lasts). And second, do you see yourself needing life insurance when you are 70, 80 or older? If your kids are self-sufficient and your spouse will be just fine between savings, inheritance and Social Security, then you may not need permanent insurance. If you have a special needs child who will need your support well into adulthood at least some permanent insurance is often a smart move. It’s also worth considering if:
- You’re in a very high tax bracket.
- You’ve maxed out all available retirement accounts, like your your 401(k) or IRA.
- You want insurance to cover estate taxes when you die.
What Type Of Permanent Life Is Right For You?
There are three major types: whole, variable and universal.
- Whole life insurance (sometimes also called “straight life” or “ordinary life”) remains in effect for a person’s whole lifetime as long as they pay all required premiums. With whole life insurance, you’re guaranteed a certain death benefit and rate of return on your cash value, which comes from the premiums you’ve paid and the interest they’ve accrued. It’s a good solution for people looking for insurance for life without any surprises.
- Variable life insurance provides a death benefit and cash value that rises and falls with the performance of underlying investments. You choose how to invest your premiums and you (not the insurance company) assume the risk. It’s ideal if you are willing to take on some risk to see the cash value grow.
- Universal life insurance is the most flexible permanent life insurance option. It has adjustable premiums, meaning you’ll have the option to pay more or less as long as you’re maintaining the cost of the insurance. This way, you can put more money into it if you want to grow its cash value. You can also adjust how much of your premium goes toward the cash value (versus paying the premiums) and then choose how it’s invested. Finally, you also have the option to pay your premiums with the cash value that has built up. So instead of writing a check to your insurance company every year, you can draw down the cash value to pay the premiums and maintain your policy. The policy is self-sustaining unless the cash value runs out.
The major difference between whole or variable life insurance and universal life insurance is that premiums are not fixed. Universal life insurance is a good choice if you want permanent life insurance but also want as much flexibility as possible, since you decide how much you pay, how the money is invested, and whether you pay the premiums using the cash value of the account or out of pocket.
If you’re thinking about permanent life insurance as a way to build cash reserves, weigh the risks and costs with the potential for growth. And talk to a pro, who will explain the return you can expect to see if you buy this type of policy.
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