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Purchasing life insurance coverage can be one of the most important and enduring financial decisions the head of a household makes for his or her family. A life policy can ensure that a family’s most pressing financial obligations are met even if a primary caregiver is suddenly absent. These include commitments to mortgage and car payments, medical bills, and student tuition expenses.
Since policy options vary as widely as the policyholder needs they cover, shopping for life insurance can also be very difficult. Before committing to one policy over another, consumers must carefully consider their coverage needs and options. Let’s get started with the basics:
What is life insurance?
Life insurance is a contractual agreement between you and an insurance provider. It guarantees that your beneficiaries, such as a spouse or child, will receive financial support after you pass away. Some types of life insurance can also provide supplemental income after you retire.
When you purchase a life insurance policy, you pay the insurance company a predetermined amount of money each month. That money is then invested, which grows over time. When you pass away, your listed beneficiaries automatically receive your invested money in a lump-sum payment.
Who Needs Life Insurance, and How Much?
People primarily purchase life insurance to provide for their beneficiaries in case of an unexpected death. And while policy sales and life insurance coverage rates are at their lowest levels in fifty years, most Americans admit that they could use more coverage:
- According to a 2013 report by the Insurance Information Institute (III), 33% of Americans believe they are underinsured. Having a life insurance policy guarantees that your beneficiaries are financially covered later in life. For instance, life insurance funds can be used to pay off medical bills or pay for funeral expenses.
- The Life Insurance Marketing and Research Association,or LIMRA, reports that 43% of consumers buy policies after specific life events like getting married, having a baby, or buying a house. When you gain a dependent, like a spouse or child, purchasing a life insurance policy gives you peace of mind knowing that they are taken care of financially if you unexpectedly pass away.
- In one J.D. Power survey of individuals who were widowed between the ages of 25 and 55, only 25% believed that their deceased spouse had adequate life insurance. Because of that, it’s never too early to purchase a life insurance policy. In fact, younger people pay lower premiums, so it’s advantageous to buy a policy as a young adult.
- A 2019 report from the American Council of Life Insurers (ACLI) determined that 90 million American families rely on life insurance products for retirement and financial security. As a policyholder, you may not reap the benefits of your life insurance policy. However, your family might need the money to get by after your death.
How does life insurance work?
There are two categories of life insurance—term life and permanent life, which includes whole life and universal life insurance. Permanent life insurance protects you for your whole life, whereas term life offers coverage for a set amount of time. The following section explains the differences between the two types of life insurance.
Term Life Insurance
Term life policies are the most popular and common coverage plans available. They are active for a specific length of time. The term could be a few months or a few decades, but the contract always comes with a definite end date; and these policies have no cash value if you survive beyond the end of the contract. Since term policies are temporary and usually have no cash value, they are best suited for individuals who want to provide a financial safety net for their families in the event of a premature death (with the exception of suicide). Since they are temporary contracts, insurers can guarantee higher benefit payouts for lower premiums.
To give you an idea, consider that a term life policy that guarantees a death benefit sum of $500,000 may cost a policyholder between 25-55 well under $500 a year while the policy is active. Alternately, annual premiums on cash value policies or term policy renewals can cost well into the thousands once you reach a certain age or if the status of your health changes.
Whole Life Insurance
This type of permanent cash value life insurance typically provides coverage for an entire life for a constant, agreed-upon premium. Whole life offers more consistency than other permanent cash value policies because the death benefit, its premiums and even the interest rate of your cash investment can be frozen at the time you buy the policy.
Universal Life Insurance
Also a permanent and cash value type of life insurance, this kind of policy provides more flexibility than whole life. Within limits, premiums and the face value can be changed over the course of the policy’s life and policyholders can renegotiate terms and adjust coverage to meet their current needs. That said, unlike with a whole life policy, the death benefit can vary based upon the performance of the money market the policy is invested in. If the investment value increases, the face value will rise. If the investment value decreases, the death benefit could decline. If you want a cash value policy, but you’re younger or you think that your coverage needs may change, a universal life policy is ideal. Because while your rate of return can vary, you will have more options to lower, raise or even borrow against your cash value throughout your life.
Types of life insurance
- Term life insurance: Term life insurance covers you for a set number of years. If you pass away before the term ends, your beneficiaries receive the death benefit.
- Whole life insurance: Whole life insurance doesn’t expire, and provides lifetime coverage. In addition to the death benefit, this type of policy also has cash value, which is a tax-deferred savings account for your beneficiaries.
- Universal life insurance: With universal life insurance, the policyholder is allowed to adjust their premium and death benefit amounts without buying a new policy. This type of insurance has cash value, and depending on the amount saved, the policyholder can choose to pay their premium with the cash value, rather than out-of-pocket.
- Variable life insurance: A variable life insurance policy has cash value, but the money doesn’t go into a savings account. Instead, the money gets invested in the stock market, which means you could grow or lose your money overtime.
- Variable universal life insurance: A variable universal life insurance policy is a hybrid of variable life and universal life insurance. Policyholders can change their premium and death benefit amount, while investing their cash value in the stock market.
- Simplified issue life insurance: Simplified issue life insurance, also known as a no-exam policy, allows you to forgo a medical exam. However, you still have to fill out a questionnaire about illnesses and preexisting conditions.
- Guaranteed issue life insurance: Guaranteed issue life insurance offers certainty of coverage. You don’t have to pass a medical exam or complete a health questionnaire in order to get approved for coverage.
- Final expense insurance: Final expense insurance will specifically help pay for end of life-related expenses. For example, this type of policy can help compensate for medical costs or funeral services.
- Group life insurance: Group life insurance is typically a term life insurance policy that is offered by your employer. However, group life insurance policies don’t always offer the amount of coverage for your needs, so it’s still recommended to consider purchasing a personal policy.
Life insurance riders
A life insurance rider is a supplemental policy that provides additional coverage for certain situations or events. You can think of a rider as added protection above and beyond what your basic policy offers.
Life insurance companies sell a number of riders, specific to your personal needs. Some examples of common life insurance riders include:
- Accelerated death benefits
- Long-term care
- Child insurance
- Accidental death and dismemberment
If you have a life insurance rider, you’re able to use the policy’s benefits prior to death. For instance, with the critical-illness rider, you would be able to use the money from your policy to cover your medical expenses for things such as cancer treatment.
How much life insurance do you need?
It can be difficult to determine how much life insurance you need, especially because it’s hard to predict what your exact financial situation will be later in life.
However, people most often undervalue how much money they’ll need when they get older, or how much money their family will need to live comfortably without their income. Because of that, it’s worth over-estimating to be on the safe side.
Consider how much money your family would need to live at their current standard of living without the benefit of your income. When making your decision, it’s important to consider things like outstanding loan balances, monthly bills, education, retirement accounts, and end of life expenses. Taking into account inflation, the total estimate is a good starting point, but a financial planner may be able to help you fine-tune your final figures.
Qualifying for life insurance
When you apply for life insurance, there is one primary qualification that will impact your rates or ability to obtain life insurance: your health. Before you can get approved for a policy, you will often be required to complete and pass a medical exam.
The exam provides a comprehensive look at your health, including your blood pressure, weight, family history, pre-existing conditions, surgeries, medications, lifestyle habits and more. Healthier people are more likely to get approved for life insurance and may receive lower premiums as it’s cheaper and less risky for insurance companies to insure adults who are healthy.
Another qualification is age. You can typically purchase a life insurance policy as young as 25. But the older you are, the harder it becomes to get coverage. Most insurance companies stop writing new policies for people in their late 70’s or early 80’s.
Other uses for life insurance
Besides financial support for your beneficiaries, there are a few other uses for life insurance. Some of the most common alternative uses are:
Permanent life insurance policies have an investment component to them. Your payments to the insurance company each month is invested in stocks, bonds and mutual funds. The best part is, the money grows tax-free.
People who have medical expenses later in life can use their life insurance policy to pay them off. This can be a huge lift for beneficiaries because they won’t become responsible for the payments if you pass away.
If you’re planning to give your heirs a monetary inheritance, one option is to leverage your life insurance policy. By listing them as a beneficiary on your policy, they’ll receive the death benefit when you pass away.
Paying off debt
Any outstanding debts can be paid off using your life insurance money. For instance, if you have a mortgage on your home, and you want your spouse to own the home outright after you pass away, you can use your life insurance money to pay it off.
Giving to charity
People who don’t have a spouse, children, or any next of kin can opt to give their life insurance payout to charity. In this case, the policyholder would list the charity as the beneficiary on their policy.
Who should I buy life insurance from?
Choosing the right life insurance provider is important because of how you want to ensure your money is being handled. You should look at each company’s financial strength rating, learn about their products, read customer reviews, and determine their rates. Below is a list of some of the most highly rated life insurance companies by J.D. Power:
- Northwestern Mutual: Northwestern Mutual has impressive ratings across the board, a variety of policies, and a superior financial strength rating of A++ from A.M. Best.
- State Farm: State Farm offers life insurance coverage in 47 states. The company offers great life insurance riders, helpful digital tools and an online calculator to help you determine how much coverage you need.
- Mutual of Omaha: Mutual of Omaha is often considered the gold standard of life insurance. It has good customer service, affordable rates and flexible policy options.
- Principal Financial: Principal Financial is known for offering fast claims handling, accelerated underwriting and competitive rates for life insurance applicants of all ages.
Who are my beneficiaries?
Your beneficiaries are the people who will receive the money in your life insurance policy—also called the death benefit—when you pass away. Typically, beneficiaries are spouses, children, or other family members or heirs. If more than one person is listed as a beneficiary, you will have to determine what percentage of benefits each person receives.
How much does life insurance cost?
There are a number of factors that impact the cost of life insurance. However, your health and age have the most significant impact on the price of your policy. Because of that, your premium will be lower if you purchase life insurance when you’re young.
The type of life insurance policy you have will also impact the price. Term life insurance policies, which only provide coverage for a set amount of time, are cheaper than whole life insurance policies, which provide lifetime coverage. Additionally, insurance riders can significantly impact the price of your premium.
Things to know before buying life insurance
Buying life insurance is a serious, long-term investment. As a result, the following considerations should be taken into account:
- Agents are trying to sell you: Remember that insurance agents are trying to sell you a policy. It’s important to understand the type of policy and the amount of coverage you need, without relying 100% on their guidance. Only you know your family’s unique circumstances and financial situation.
- Life changes unexpectedly: We’re not always prepared for the changes that happen in our lives. Family members pass away unexpectedly, babies are born, people divorce, and so on. It’s important to keep your life insurance up-to-date to account for life changes.
- You could be underinsured: If you have a life insurance policy with an investment component, remember that you could lose money. If that happens, you and your family might not have enough coverage when you really need it. Be careful and strategic about your investing decisions, and understand the risks.
How to save money on life insurance
Life insurance isn’t necessarily cheap, but there are ways to save on your premium. Below are some money-saving tips:
Buy insurance when you’re young
Because age is a significant factor in the cost of life insurance, buying a policy as a young adult can help you save a significant amount of money on life insurance.
Smoking is viewed as a major health risk to life insurance providers, and consequently, people who smoke generally have more expensive premiums. If you are a smoker, quitting is one effective way to save on life insurance costs.
Pay your premium in full
Life insurance providers usually offer a discount if you pay your annual policy in full, rather than in monthly installments.
Get term life insurance
Term life insurance is always going to be cheaper than permanent life insurance. If term life insurance fits within your financial needs, this type of policy can save you money while still providing important benefits.
- Life insurance is valuable, and you’re never too young to buy a policy.
- Before you purchase insurance, it’s important to understand the type of policy you need, and consider necessary or beneficial riders.
- The best life insurance companies are financially strong, have good customer service, and offer flexible policy options.
- Life insurance can be costly, but there are ways to save money.
If you’ve ever considered purchasing life insurance, it’s best to purchase life insurance when you’re young and healthy, and before you’ll need to take advantage of your policy’s benefits. Before purchasing a policy, make sure you know what type of life insurance you need and how much coverage is right for you.
Use this guide to help you learn more about what life insurance covers, what your policy options are, and what to look for in a provider.