Three Tips for Buying Life Insurance
Purchasing life insurance can get pretty complicated. Since each individual’s situation is different, you probably need to sit down with a knowledgeable insurance broker. But here are some of the basics for what you need to know.
The death benefit from a life insurance policy can be used in many ways. The proceeds can be tapped to create an estate for beneficiaries; to pay death taxes and other estate settlement costs; to pay off business or personal loans; to build a college fund for children. In other words, the money can protect survivors against the financial distress suffered with the loss of a family income provider. Additionally, when used correctly, insurance policies offer income and estate tax advantages. Proceeds paid to beneficiaries are generally excludable from taxable income and pass outside the probate process.
There are multiple types of policies, which basically can be divided into term and permanent. Term life policies are designed to meet temporary needs during a specified period of time. For instance, a young parent may wish to buy a 25-year policy that lasts until the kids are through college and out on their own; or a 30-year policy for the duration of a 30-year mortgage liability. Policy holders pay level premiums for a fixed period. Term life policies have no cash value and are paid only if the insured dies within the policy period.
Permanent policies may be divided into whole, variable and universal life. Permanent policies, which provide lifelong protection, are designed for needs that never go away, such as the liquidity to meet estate taxes. The policies accumulate cash value, and many policies have provisions allowing policy owners to borrow or withdraw a portion of the accumulation.
Whole life policies typically generate a low rate of investment return and are fairly inflexible. Universal life policies provide the flexibility for holders to change the death benefit and premium payments if circumstances change during the holder’s lifetime. Variable life is similar to whole life in that premium payments are level and generally provide a minimum guaranteed death benefit, but these policies permit policy owners to invest a portion of each premium payment in asset classes such as stocks and bonds. The death benefit and cash value of variable policies increase or decrease based on the performance of the investment options chosen (though the death benefit will not drop below an initial guaranteed amount).
There are different ways to calculate the value of a human life. One method is to value the policy buyer’s human capital—the present value of expected future labor income over the course of a working lifetime. The value of one’s human capital is greatest in early career (when financial capital in the form of savings is typically small) and gradually declines over one’s working lifetime. Life insurance is a way of securitizing your human capital and passing it on to your family members in case of death. A second approach is financial needs. Here, you start by calculating survivors’ needs, such as mortgage payments, educational and other living expenses, to arrive at a value. If you need help with the calculations, there are useful tools available online, such as: http://www.lifehappens.org/life-insurance-needs-calculator/.