Life insurance basics, Part 1
- By Milt x_Zall
- Jan 18, 2001
Life insurance is the foundation of financial security for you and your
family. It protects your financial resources against the uncertainties of
life so you can plan for the future.
Choosing a life insurance product is an important decision, and it can
be complicated. As with any major purchase, it is important that you understand
your needs and the options available to you.
The main purpose of life insurance is to provide cash for your family
after you die. The money your dependents will receive (the "death benefit")
is an important financial resource: It can help pay the mortgage, run the
household, and ensure that your dependents aren't burdened with debt.
The proceeds from a life insurance policy could mean that your family
won't have to sell assets to pay outstanding bills or taxes. What's more,
there is no federal income tax on life insurance benefits.
Where to Begin?
Start by evaluating your family's needs. Gather all your personal financial
information and estimate what your family will need after you're gone. Include
ongoing expenses (such as day care, tuition or retirement) and immediate
expenses at the time of death (such as medical bills, burial costs and estate
taxes). Also consider that your family also may need funds to help them
finance a move or pay expenses while job hunting.
Remember that life insurance provides financial protection. If protection
is not your primary goal, you should consider other financial products.
So, how much life insurance should you buy? While there's no substitute
for evaluating needs, one rule of thumb is to buy life insurance equal to
five to seven times your annual gross income.
Life Insurance Options
There are many kinds of insurance, but they generally fall into two
1. Term insurance. This type provides protection for a specific period
of time. It pays a benefit only if you die during the term. Some term insurance
policies can be renewed when you reach the end of the term, which can range
from one year to 30 years. The premium rates increase at each renewal date.
Many policies require that you present evidence of insurability at renewal
to qualify for lower rates.
2. Permanent insurance. This type provides lifelong protection. As long
as you pay the premiums, the death benefit will be paid. These policies
are designed and priced for you to keep over a long period. If you don't
intend to keep the policy for the long term, this may be the wrong type
of insurance for you.
Permanent policies are known by a variety of names: whole, ordinary,
universal, adjustable and variable life. Most have a feature known as "cash
value" or "cash surrender value." This feature, not found in most term insurance
policies, provides you with some options. You can cancel or "surrender"
the policyin total or in partand receive the cash value as a lump
sum. But if you surrender your policy in the early years, there may be little
or no cash value. If you need to stop paying premiums, you can use the cash
value to continue your current insurance protection for a specified time
or to provide a lesser amount of protection covering you for your lifetime.
You can usually borrow from the insurance company using the cash value
in your life insurance as collateral. Unlike loans from most financial institutions,
the loan is not dependent on credit checks or other restrictions. You ultimately
must repay any loan with interest or your beneficiaries will receive a reduced
With all types of permanent policies, the cash value of a policy is
different from the policy's face amount. The face amount is the money that
will be paid at death or policy maturity. Cash value is the amount available
if you surrender a policy before its maturity or your death. Moreover, the
cash value may be affected by your insurance company's financial results
or "experience," which can be influenced by mortality rates, expenses and
Part 2, Next Week
Next week, I'll delve more deeply into the types of life insurance and
discuss the advantages and disadvantages of each.
Zall, Bureaucratus columnist and a retired federal employee, is a freelance
writer based in Silver Spring, Md. He specializes in taxes, investing, business
and government workplace issues. He is a certified internal auditor and
a registered investment adviser. He can be reached at [email protected].