Understanding Your Life Insurance Options

Protecting Your Loved Ones

How would your loved ones manage financially without you? It’s difficult to think about death, but planning for this inevitable is the best way to ensure your family will be taken care of after you die. Just 60 percent of Americans have some sort of life insurance policy, but almost 90 percent think having one is a must. If it’s so important, why doesn’t everyone have life insurance?

CONTRIBUTING EXPERTS
Brad Cummins
Brad Cummins Independent life insurance agent
Karen Lee
Karen Lee Certified financial planner

This guide was written by

Claire Swinarski

A 2015 study found consumers are intimidated by the process of purchasing life insurance, saying they thought it was too expensive and didn’t know how much they needed or what type of policy to get. Don’t let those fears stop you from protecting your family’s future. Get a breakdown of why life insurance is a good investment, the different types of plans available and the best practices when shopping around. That way, your family members will have the financial support they need even when you’re no longer with them.

Common Types of Life Insurance

With life insurance, there are two major types of plans – term life and permanent life, which includes whole life and universal life. Term life is perhaps the most straightforward and offers temporary coverage at a relatively low cost. Permanent life insurance provides lifetime coverage and consists of different subcategories. Learn more about the most common options below.

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Find Out Which Policy is Right for You

Below is a simplified flow chart to help you decide which type of insurance may be right for you, along with more information on policy types:

What type of life insurance should I get?
I need short-term coverage
I need long-term coverage
Term life insurance
How It Works

Short-term coverage that pays out only if the policyholder’s death occurs during the set term.

For Whom It’s Meant

People who are high-need with a lower income or people who only want coverage during a particularly vulnerable time (e.g. raising children who are under the age of 18)

Pros
  • Much lower premiums than permanent life
Cons
  • Expires
  • If you want to renew, premiums will go up dramatically once your term ends
But I have a limited budget
My budget isn’t a concern
Permanent life insurance
How It Works

Policies last a lifetime (or until age 100 or 121) and are paid out whenever you die

For Whom It’s Meant

People who want to be permanently covered and are able to afford higher premiums

Pros
  • Once you’re covered, you’re covered for life, regardless of aging and changes in health
  • Builds a guaranteed cash value
Cons
  • Much higher premiums than term life
I want fixed premium payments
I want adjustable premium payments
Whole life insurance
How It Works

Type of permanent life insurance offering a death benefit and a savings account

For Whom It’s Meant

People who want a straightforward plan with fixed premium payments and a guaranteed death benefit

Pros
  • Tax-free wealth accumulation
  • Offers fixed premiums
  • The cash value accumulation is yours, even if you let your policy lapse
Cons
  • Premiums are high
  • Policies last a lifetime (or up to age 100 or 121) and pay out their “face value,” which is taxable if you’re still alive
I want to invest in stocks, bonds and/or mutual funds
Universal Life
How It Works

Type of permanent life insurance where you have greater control over how your money is spent

For Whom It’s Meant

People who want flexibility in their plan

Pros
  • Flexible premiums and death benefits
  • In case of a sudden loss of finances, you can use your cash payments to pay your premiums
Cons
  • Higher risk because affected by interest rates
  • If projected returns don’t pan out, insurance company can reduce your policy’s cash value, even down to zero
  • Policies can lapse unexpectedly if interest rates fall below projections or insurance costs and/or administrative expenses rise
I want to invest in stocks, bonds and/or mutual funds
Variable Life
How It Works

Type of permanent life insurance that combines death protection with a savings account where you can invest in stocks, bonds, and/or money market mutual funds

For Whom It’s Meant

People with experience investing and want to boost returns by choosing their own allocations

Pros
  • Policy’s cash value may grow more quickly, depending on policyholder’s risk appetite in investing
Cons
  • Higher risk since cash value and death benefit fall solely on policyholder, so there’s no minimum cash value guarantee
  • Higher fees
Variable Universal
How It Works

Permanent life insurance combining variable life and universal – policyholders can invest and easily change insurance coverage

For Whom It’s Meant

People who want the power of investing and the flexibility of payment options

Pros
  • Policy may grow more quickly with smart investments
  • Additional flexibility because policyholders decide amount and frequency of premium payment
Cons
  • Higher risk because underlying assets can rise or fall, affecting cash value; insurers don’t guarantee minimum cash value
  • Higher fees

Why Buy Life Insurance?

Life insurance provides protection to your loved ones by paying out a predetermined sum of money upon your death. Typically, life insurance rates take into consideration your age, gender, location, occupation, weight, nicotine use and health history.

Many mistakenly believe only people with children need life insurance, but Brad Cummins, founder and owner of Local Life Agents, said many different life circumstances warrant protection. “Older people can also need life insurance for a number of reasons, such as replacing lost retirement income, paying off debt when a spouse dies, paying for estate taxes, or even making sure that a grandchild is able to go to college,” Cummins explained.

Also, regardless of your age, anyone who doesn’t want family members to feel burdened with funeral costs should consider life insurance. “Today, the cost of a funeral and related expenses such as a burial plot, head stone, flowers, transportation, and memorial service can be in the neighborhood of $10,000,” Cummins said. “It can be difficult for families to come up with that amount of money—especially if it was due to an unexpected event. Having even just a small life insurance policy in force can provide the protection that you need to cover these types of expenses.”

The Different Ways to Use Life Insurance Benefits

Paying for final expenses

Final expenses can be costly. Life insurance can help cover a range of funeral and burial costs as well as outstanding medical bills.

Paying off debt

From home loans to college loans, debt weighs on many people. Your beneficiaries can use life insurance benefits to pay off your outstanding debts, ensuring your loved ones don’t inherit the burden.

Income replacement

In a dual-income household, it can be difficult to transition to just one salary. Life insurance can serve as income replacement so your spouse and kids don’t struggle to make ends meet. It can cover every day expenses and/or larger costs such as mortgage payments or your children’s college education. Even if you are a stay-at-home parent, benefits can cover the cost of daycare or a nanny.

Long-term care

Many life insurance policies offer a long-term care (LTC) rider, which allows you to use your death benefit for services such as home health care, assisted living or a nursing home instead of having to purchase stand-alone long-term care insurance. If you use this benefit, your beneficiaries will get what’s left of your death benefit when you die (or a specified percentage of the policy’s amount if your plan has a guaranteed minimum benefit).

Paying federal estate taxes

If the net value of your estate is more than the exempt amount set by Congress at the time of your death, your estate will owe federal estate tax. Life insurance can pay for that.

Leaving an inheritance or making a donation

A life insurance policy with a named heir as the beneficiary ensures that he or she will receive an inheritance when you die. If your heirs don’t need this money, you can donate to charity instead. You can do this by naming a charity as your beneficiary, which means you’ll maintain ownership of your policy, including access to the cash value, while you’re alive. This option, however, means you won’t be able to get an income tax deduction for your donation. If you want to receive a charitable tax deduction, you can transfer your policy to the charity.

How Much Life Insurance Do You Need?

There is no one-size-fits all life insurance policy. To start with, consider what phase of life you’re in and who relies on you financially. Keep in mind, though, that these things will change throughout your life. Below is a quick look at how coverage needs could vary as you grow older:

  • You’re single with no dependents and few responsibilities
  • You’re married, with a house and children (or planning for children)
  • Your kids will be in college soon and your spouse will need income protection
  • Your kids are independent and about to graduate from college and your mortgage is paid off
  • You need to cover final expenses, want to leave a legacy and/or your spouse will need retirement income

Questions to Ask Yourself Before Purchasing a Policy

When buying a life insurance plan, there are many questions to consider. Make sure you know your concerns, needs and goals before meeting with an insurance agent. Here are some things to ask yourself before purchasing a policy:

What stage of life am I in?

Are you young and single, and merely looking to cover funeral costs and student debt? Or do you have people who depend on you financially? Some policies allow you to adjust down the road, so consider buying the best plan to fit your needs right now and update it later if necessary.

Is building long-term wealth a priority?

Are you looking for insurance for only a set period of time, or are you planning to grow your wealth through compounding interest? Are you comfortable with investing or does the risk make you uneasy? Your answers to these questions will help you figure out which policy you need.

How many dependents do I need to support?

How many people do you support financially? Is it just your spouse, or do you have children, too? Are you planning to have more children in the coming years? What about your grandchildren?

How big of a life insurance payout will my family need?

Whether you’re the breadwinner of your household, the caretaker of a disabled sibling or a stay-at-home parent, calculate how much money your dependents would need to keep their worlds functioning after you die. This includes everyday costs such as food, gas and clothing as well as larger expenses such as mortgage payments and college tuition.

How much can I afford to pay in premiums?

Although you may want to leave your family with a half a million-dollar nest egg or more, consider what you can afford to pay in premiums right now. Look for a plan that can be adjusted as time goes on. That way, you’ll have the flexibility to increase what you can leave your family in the future.

How can I improve my chances of getting a good rate?

Your health is a huge factor in your life insurance rate. If you’re a smoker, the number one thing to do is quit smoking for at least a year because smoking can increase insurance premiums up to 300 percent, according to financial planner Karen Lee. Some companies even require two years for a non-smoker rate. Hiring an insurance broker may also help ensure a good rate.

Do I want/need disability insurance?

Some life insurance policies come with disability coverage, which may be a consideration if you’re at risk for developing an on-the-job injury or illness.

How to Choose a Life Insurance Policy

Once you’ve taken the first steps in evaluating your unique life situation, it’s time to get down to the nitty gritty of choosing and buying a life insurance policy. Listed below is a step-by-step process on how to do that.

1

Think about the type of policy you want

Ask yourself what do I want my life insurance to do? Think of it as a spectrum: You can either get a policy that would simply cover the cost of your funeral or one that would leave long-term wealth for your beneficiaries. Your choice will depend on the amount you’re able to spend on premiums as well as your comfort level – life insurance that involves investment is riskier. Some people would prefer to have a more straightforward guarantee.

2

Decide how much coverage you will need

Many experts will recommend 10 to 15 times your annual salary, but this can vary. Even if you don’t have a high income, you may still need an ample amount of life insurance. For instance, if you are a stay-at-home parent, you may want to leave enough for full-time childcare, which can be expensive.

3

Choose a trustworthy company and/or agent

Life insurance is a contract, and your payout is only as good as your carrier. Research the companies you’re considering and choose one with a strong financial rating, good reputation and excellent customer service. Also, make sure you feel comfortable asking questions. Vet prospective agents by finding out if they belong to any professional organizations and by talking with their references. Recommendations from friends and family are a good place to start.

4

Consider how your needs will change over time

Again, consider a flexible policy. Many young couples begin with term life insurance, but might eventually convert to whole. “Term life insurance is like renting an apartment versus buying a house,” Lee said. “You build no equity, but your beneficiaries get a death benefit if you die during your term, as long as you pay the premium. It’s also inexpensive compared to whole life, so might be the best choice for a young family with limited income.” Later down the line, however, you might want permanent coverage, and you may also have the income to pay higher premiums.

Tips for Shopping for a Policy

When shopping for life insurance, don’t settle on the first policy and company you find. Try the following tips to help you become a savvy shopper.

Don’t get oversold

While agents can help you assess your needs, you’re the person who can best anticipate the financial hardship that will be placed on your loved ones when you pass. Comparison shop with a number in mind to avoid being swayed into spending more than you are able or need to.

Carefully assess the insurance company’s rating

This can’t be stressed enough. According to Lee, it’s vital to consider the rating and reputation of your insurance provider. You may be on a tight budget, but you also want to make sure you’re putting your money somewhere reliable. With financially strong insurance providers, there is little doubt about their longevity and ability to pay a claim, which might be necessary if you’re around for a while. “Don’t overlook the ratings of a strong insurance company to go with one that offers the cheapest coverage,” Lee said. “Go with an insurance company that has an A or A+ from the A.M. Best rating company.”

Compare prices

“When shopping for a life insurance policy, it is always a good idea to compare more than just one or two carriers,” Cummins said. He explains that while all carriers have certain criteria for evaluating applicants, these factors are not identical. As a result, premiums can differ greatly between insurance companies, even for similar amounts of coverage. Consider hiring an insurance broker to help you get multiple quotes or search online for affordable options.

Learn the vocabulary

Terms associated with life insurance can sometimes sound like their own language. Dividend, premium and beneficiary may not be words you’re comfortable using, but your insurance representative will definitely use them a lot. Make sure to understand the vernacular before you get serious about purchasing a policy to appropriately assess the costs and benefits. (The glossary below is a good starting point.)

Life Insurance Glossary

Adjustable premium

Premium rate that changes over a period of time, according to factors agreed to by the purchaser and the carrier. An adjustable premium is also known as a variable premium. (See also: decreasing premium, fixed premium and flexible premium.)

Agent

A person who sells, negotiates and/or services insurance policies. An agent can work for a larger company or can be someone who works independently, without corporate affiliation.

Annual renewable term insurance

This plan is renewable for a pre-determined number of successive terms by the policyholder. In addition, the insured party is not required to have a medical exam before being accepted for this insurance.

Annuity

This is a long-term investment that can be combined with life insurance for an overall retirement strategy. It provides steady income during retirement. Regular disbursements are made to the policyholder or a designated party. Annuities can pay out for a specific period of time or for the life of a person or multiple people.

Beneficiary

The person or organization designated when you purchase a policy to receive payments from your policy when you die. (See also: primary beneficiary and contingent beneficiary.)

Cash value

Also called the cash surrender value or surrender value, this is the cash amount that will be paid to a policyholder by the insurer when the contract is cancelled. It’s also the amount that can be borrowed against.

Churning

An illegal practice in which agents sell new or replacement policies to a client, simply to earn more commissions. The agent uses the original policy’s cash value to purchase a replacement policy that generates a commission.

Claim

An action taken by a beneficiary, asking the insurer to provide payment in accordance with the terms of the policy.

Commission

Payments by insurance companies to agents when they sell policies. For life insurance, commissions are based on a percentage of the premium you pay.

Contingent beneficiary

A contingent beneficiary is often the person who will receive the benefits if the primary beneficiary has died at the time the benefit is to be paid. A contingent beneficiary may also be someone who can only receive the insurance proceeds if previously stated conditions have been met (such as those outlined in a will). (See also: primary beneficiary.)

Convertible term insurance

This type of insurance policy allows you to convert it into permanent insurance without a medical assessment (as subject to stipulated policy conditions). With convertible term insurance, the insurer must renew the policy no matter the health of the insured.

Corporate-owned life insurance

Known by the acronym COLI, this is life insurance on employees’ lives that is owned by their employer. Benefits of this insurance can be payable to the employer or the employee’s families. COLI was originally purchased on the lives of key employees and executives by a company to protect against losses if a key employee died.

Coverage

Amount of liability or risk taken on and paid out with benefits to designated beneficiaries upon the death of the policyholder or person designated in the policy.

Death benefit

Upon the death of the person named in a life insurance policy, the designated beneficiary or beneficiaries will receive a payment as stipulated by the terms of the policy called a “death benefit” or a “survivor benefit.”

Decreasing term insurance

The death benefit payable in this type of annual renewable term life insurance decreases at a stipulated and predetermined rate over the life of the policy. The policyholder pays the same amount in periodic premiums, but the value of the policy reduces as the insured party grows older. Can be ideal if you only want to cover debt that decreases over time, such as loans.

Dividends

Usually a feature of whole life policies. A percentage of the insurance company’s profits are paid to policyholders, who are able to determine how they want these surplus funds to be paid out or reinvested.

Face value/amount

Value of a policy provided when it reaches a designated maturity date or when the policyholder dies. It is a stated dollar amount the policy’s beneficiaries will receive.

Final expenses

Expenses that occur when a person dies, meaning they often have to be paid by the beneficiaries. Typically, this includes expenses that are incurred as a direct result of death, such as funeral arrangements. Some insurance agents, however, may also consider such items as medical and hospital bills, debt, owed taxes, court expenses associated with probating of a will and other legal fees as a final expense.

Fixed premium

A payment for a life insurance policy that does not change over the life of the policy, so the same amount is paid in every billable period. Fixed premiums can have fewer financial risks for the policyholder. (See also: adjustable premium, decreasing premium and flexible premium.)

Flexible premium

With this type of life insurance, the policyholder can modify the amount and scheduling of premium payments. (See also: adjustable premium, decreasing premium and fixed premium.)

Juvenile life insurance

Juvenile life insurance, also called child life insurance, serves two purposes. It can help a family with unexpected costs associated with a child’s death. If the child survives to adulthood, it can be used as a tax advantaged savings vehicle. Depending on stipulations of the policy, it can even carry potential for lifetime benefits.

Level term insurance

This type of policy offers a way to even out the cost of payments. The cost is equally distributed over the term of the premium period, offering greater budgetary controls for the policyholder.

Life insurance

Any insurance that pays out a sum of money, called death benefit or benefit, either upon the death of the insured individual or after a predetermined period has elapsed.

Liquidity

Cash value in a life insurance policy that can be accessed by the policyholder, depending on restrictions and stipulations as stated in the policy. Insurers must, by law, maintain sufficient cash reserves to allow them to access liquid funds for payments as requested.

Lump sum payment

A method of payment in which the total amount of value is paid out in one single payment upon the death of the insured. After the payment of the lump sum, no further payments are made.

Maturity

All life insurance policies carry a maturity date, usually the 100th or 121st birthday of the insured. If the insured person survives to the maturity date, the policy usually pays either the death benefit or the cash value directly to the insured.

Medical examination

Some policies stipulate the person seeking coverage must receive a medical examination, typically from a third party paramedical service specified by the insurance company. This exam may also need to be supplemented by an Attending Physician Statement. If the examination does not reveal any significant health issues that could affect longevity, the provider will note this for the insurer, who will then take this into account when setting the premium rate.

Mortality deduction charge

This is the actual cost of the life insurance coverage. It’s an amount periodically deducted from a policy’s account value. It increases as you age, but cannot exceed the maximum limit as stipulated in the policy.

Ordinary life insurance

Also called “whole life insurance” or “straight life insurance,” this is a life insurance policy which is guaranteed to remain in force for the insured person’s lifetime, as long as the stipulated required premiums are paid or the person lives to the policy’s maturity date.

Permanent life insurance

Life insurance policies that do not expire, and which combine a death benefit with a savings element. They are unlike term life insurance, which has an expiration date and no savings element.

Policy

A written contract, signed by an insurer and a policyholder, ratifying the legality of an insurance agreement.

Policy owner

Person named in the written contract who has control of the policy. In most cases, the policy owner is the person whose life is being insured, but the owner can also be the policy’s beneficiary.

Preferred risk

If your likelihood of risk is determined to be lower than that of the standard applicant for a life insurance policy, then you are considered a preferred risk.

Premium

Amount paid by a policyholder to secure coverage as designated in the terms of the life insurance policy.

Primary beneficiary

First person who will receive benefits from the life insurance policy. If this person or persons has died, a contingent beneficiary will receive the benefits. (See also: contingent beneficiary.)

Reserves

The portion of all of an insurers’ received premium payments which have been set aside to fully pay any claims made against current life insurance policies.

Rider

A provision of an insurance policy purchased separately from a basic policy providing additional benefits at additional cost. However, depending on the policy and company, some riders may be offered at no additional cost and the applicant will have the option to accept or reject it. Riders are commonly purchased for disability, guaranteed insurability, critical illness, accelerated death, child protection and accidental death.

Risk class

This classification is a factor in determining the premium on your life insurance policy. Using underwriting guidelines, insurers examine such factors as medical history, smoker status, BMI, medical exam results, family medical history, driving record, and hazardous activities to determine the risks of the insured.

Risk management

Sometimes called “insurance risk management,” this is the process of identifying and analyzing loss exposures and taking steps to minimize the possible financial impact of the risks they impose.

Single premium

When you pay the full premium amount up front and no further payments are due.

Standard risk

If you’re applying for a life insurance policy and you fit the physical, occupational and other standards on which the normal premium rates are based, then you’ll be classified as a standard risk.

Sub-standard risk

If you’re applying for a life insurance policy and you do not meet the requirements on which the normal premium rates are based, then you’ll be classified as a sub-standard risk and you’ll be charged an additional premium.

Suicide clause

Clause stipulating the insurer is required to pay only the reserve or the total of premiums paid to date if the policyholder commits suicide within a designated period.

Surrender charge

Charge for cancelling a life insurance policy. This is used to cover the costs of keeping the insurance policy in the provider’s system.

Term

Refers to the time period during which a life insurance policy will be in effect.

Term life insurance

A short-term coverage option that pays out benefits only if the death of the insured occurs within a specified number of years or before a stipulated age. Unlike permanent life insurance, term life doesn’t offer a cash value.

Underwriting

When an insurance company examines risk for a potential policy and either accepts or denies it, and then specifies a rate.

Uninsurable risk

A risk a potential insurer declines to cover, usually because the chance of loss is too likely or it would be too expensive to cover.

Universal life insurance

Type of life insurance in which both premiums and coverage are adjustable.

Valuation

Calculation of premium reserves and outstanding risk, used to determine the value of an insurance company.

Variable life insurance

This type of policy has a face value and/or a duration that varies according to the value of underlying securities.

Whole life insurance

This is a type of permanent life insurance policy that is effective for a person’s entire life, paying benefits when the insured person dies, no matter when in the life of the policy that event occurs.

Updated: July 27, 2017