Like everyone else, you have people in your life you care about and who depend on you for support—spouses, children, elderly parents, and so on. Beyond food, shelter, and other immediate survival needs, you have a vested interest in safeguarding the long-term financial security of these people. Whether it be your spouse’s retirement needs, your children’s college education, or your parents’ nursing home care, you want to make sure that all your loved ones will be able to meet their expenses and attain their goals. Hopefully, you’ll be around so that you can take an active role in seeing to everyone’s needs. But nothing is certain.
With this in mind, you need to take appropriate planning steps to minimize the possibility of financial losses that your loved ones could suffer if you meet with an untimely end. The strategies you can use to provide adequate resources for your survivors in the event of your premature death include using government benefits and earmarking existing assets. However, the funds triggered by Social Security and other government programs will likely be insufficient to meet the various costs your survivors will incur. And most of us simply don’t have sufficient resources to set aside adequate amounts of money for the future. As a result, many of us have to secure the protection we need and want through personal life insurance.
How it Generally Works
When you purchase a life insurance policy for protection, you enter into a contract with the insurance company that writes the policy. The company agrees to indemnify or cover you in the event of your death by providing your designated beneficiary(ies) with a certain amount of money in death benefits. To obtain this financial coverage and the peace of mind that comes with it, you must pay your company a specified price known as the policy premium.
The insurance contract, however, is a special kind of contract in that you are not bound to pay your company premiums and can stop paying them at any time, in which case the company cannot force you to pay. Of course, if you stop paying, they will stop covering you. You can terminate the contract any time you want. Your insurance company, on the other hand, will generally be bound by the terms of the contract to pay the specified amount in death benefits to your beneficiary(ies) when you die as long as you have been paying the required premiums in a timely manner. In some cases, the premium may change from one year to another based on your age, health, and other factors. In any event, both sides generally benefit from this contractual arrangement. Your insurance company generates profits by taking advantage of risk pooling and the law of averages, and you obtain valuable protection that might otherwise be unaffordable or unavailable to you.
Caution: Any guarantees associated with payment of death benefits, income options, or rates of return are based on the claims-paying ability of the insurer. Policy loans and withdrawals will reduce the policy’s cash value and death benefit.
Things You Need to Think About: An Overview
Unfortunately, personal life insurance is usually not as simple as it might appear on the surface. It’s not just a matter of paying a few dollars in exchange for a promise to pay many more dollars to your loved ones if something happens to you. Life insurance is, in fact, quite involved and brings into play a variety of complex issues.
For starters, you need to navigate the sea of different policy types and pick the particular kind of policy that best suits you. You need to determine the appropriate type(s) and amount(s) of life insurance coverage based on your coverage needs, your financial circumstances, and other factors. Even after you’ve made all these complicated decisions, there will still be much work to do. You need to periodically review both your policy and the insurance company behind it. This way, you will be able to assess whether the policy still offers a good match for you and measure the extent to which you have been satisfied with the company/policy. Depending on the outcome of your review, you may want to replace or exchange the existing policy, change the level or type of coverage it provides, leave it as is without making any changes, or transfer ownership of the policy to another party. As you deal with life insurance through all the steps of this lengthy process, you should be aware of any applicable tax considerations and understand the general contractual obligations contained in a typical policy.
Caution: Because of the number and complexity of the issues involved, you should consult additional resources when dealing with life insurance. These may include a financial planner, a life insurance professional, and a tax advisor.
How do You Choose an Insurance Company and Agent?
The choice of an insurance company may be easy if you already have other types of insurance (auto, homeowners, health, for example) with a company that you have been happy with. If not, you need to do some research to choose a good company. You can rely on word of mouth and written resources to give you some idea of a company’s reputation for providing good customer service and quality products. If you want more concrete, quantitative information, consult your financial professional or obtain a rating of the company from a ratings service organization. These ratings are based on such quantitative measures as a company’s record of meeting its projected dividends and the number of policies retained or terminated in a given year.
Choosing a competent, trustworthy agent who will keep your best interests at heart should be another of your priorities. You can ask your friends for referrals, request a list of client recommendations, and find out whether the agent is paid on a fee basis or a commission basis. In any case, since choosing an agent usually means choosing his or her company, your screening process should be fairly thorough. This process also applies if you choose a broker.
What Type of Policy Should You Have?
After you’ve chosen a reputable insurance company (and agent or broker) in which you have confidence, one of the first questions you should ask yourself is what type of policy you’ll need. In most cases, the choice is far from clear. The type of policy you pick should be the type that comes closest to providing the range and kind of coverage you need. In effect, asking what type of policy you need is basically another way of asking what type of coverage you need.
To answer either question, you have to pinpoint exactly what your coverage needs are, based on such factors as age, health, finances, and family circumstances. A young person will have vastly different coverage needs than an elderly person, just as a healthy person will have different needs than a chronically ill person. Then you can wade through the various types of policies to find the best match. Do you need term life or cash value? Do you need whole life, universal life, variable life or variable universal life? You will find that each type has its own unique characteristics. For example, some have a level death benefit, while others have an increasing death benefit option; some have to be renewed periodically, while others do not; some do not allow you to borrow against the policy, and so on (see Provisions). However, the differences may be more subtle than that. If so, you need to be careful and attentive to detail so that you can make the right choice between seemingly similar types of policies.
Caution: Some cash value life insurance policies do not offer a guaranteed return (e.g., variable universal life). These policies may gain or lose value based on the performance of the underlying investments.
Caution: Variable life and variable universal life insurance policies are offered by prospectus, which you can obtain from your financial professional or the insurance company. The prospectus contains detailed information about investment objectives, risks, charges, and expenses. You should read the prospectus and consider this information carefully before purchasing a variable life or variable universal life insurance policy.
How Much Coverage do You Need?
This may be the question that clients most frequently ask insurance agents and financial planners. Do you need $50,000 of coverage, $100,000, or maybe more? Unfortunately, there is no simple formula that will instantly yield the right answer.
As with choosing the right type of policy, determining an appropriate level or amount of coverage brings into play a combination of factors, ranging from your health to your current financial situation to your anticipated family expenses down the road. If you earn $200,000 a year and want your spouse to be able to maintain the same standard of living when you’re gone, you’ll probably want to have more coverage than someone with an income of only $50,000. If you have substantial investments that will generate a considerable retirement income for your spouse, you can probably opt for a lower death benefit amount than someone with no asset holdings.
On the other hand, if you have three children who will all be heading off to college within the next 10 years, you may want a higher coverage amount to ensure that they’ll all be able to attend college if something happens to you. These are only a few of the possible considerations that might affect your decision about coverage level. Although there is no simple magic formula to give you a definitive answer, there are several mathematical formulas that can help you figure out how much coverage you’ll need. The problem with many of these formulas is that they often fail to take into account other sources of income to which your beneficiary(ies) will have access when you’re gone.
In any case, most insurance professionals recommend coverage equal to between 5 and 10 times your annual income. However, when your insurance agent or broker proposes a figure, you shouldn’t automatically take his or her word for it and instead, should get a second opinion or develop a system for estimating your coverage needs on your own.
Making Your Final Choice
Ultimately, your final choice of a policy should be based on the topics addressed above:
- How do you choose an insurance company and an agent or broker?
- What type of coverage do you need and, in turn, what type of policy do you need?
- How much coverage do you need?
The rest should be easy if you have selected a company and an agent or broker, decided what type of coverage and the type of policy you need, and determined an appropriate coverage level figure.
Example: Say that you’ve decided to go with James Hart of Four Aces Insurance. You need $100,000 of death benefit coverage and feel certain that the type of coverage provided by an adjustable life policy is perfect for you. With Mr. Hart’s help, you can weed out his company’s various life insurance policies according to the criteria you have established, and pick the one that’s best for you.
Should You Review Your Policy?
You should generally review your existing policy every one to five years. After all, you want to keep tabs on your insurance company’s performance to see if they’re doing a good job. And, more importantly, you want to make sure the policy you chose still suits your needs and circumstances for both the type and amount of coverage it provides.
Should You Make Any Changes?
Changes to your existing life insurance policy can take a number of different forms. At one extreme, you can replace the existing policy by switching to a new policy with an entirely different company. You can also exchange the policy, which involves trading in your existing policy for a different one with the same company. A less drastic measure is to keep the existing policy in place while changing the level of coverage it provides in the form of death benefits payable to your beneficiary(ies). For entirely different reasons, you may be inclined to transfer full or partial ownership of the policy to an institution or to another individual. Your particular circumstances in each case will dictate whether any of these changes are appropriate.
Keep in mind, however, that some of these changes will have adverse consequences, including tax ramifications and costs to you. Thus, the drawbacks of any change you are considering should always be weighed against the perceived advantages. In many cases, you may decide that the best strategy is to just leave your existing policy alone without making any changes at all.
Things to be Aware of
You may approach life insurance with great trepidation. The subject can be complex, depressing, and intimidating as well. The process of trying to determine if and when you should make any life insurance changes can be difficult too. Nonetheless, as you go through each of these processes, you should gain a fair understanding of some life insurance basics.
For one thing, you should at least be aware of the basic contractual obligations governing your life insurance policy or, for that matter, any life insurance policy. Mostly, these include the policy’s provisions, options, and riders. An example of a provision is the suicide clause, which states a policy won’t cover death by suicide for a specified time frame, generally the first two years. An example of an option would be a dividend option that gives you multiple choices as to what you can do with any dividends payable on the policy. The accelerated death benefit for terminal or catastrophic illness constitutes one example of a rider. You should actually read your policy to familiarize yourself with some of these terms so that you can discuss it with your agent.
Also, since life insurance involves so many complex tax issues, you should enlist the aid of a qualified tax advisor to help you understand some of these issues and sort out the tax implications of any decisions you make. Among other things, you should know that life insurance has a very specific definition for income tax purposes, that the growth of a cash value policy is usually tax deferred, and that there may be special tax rules governing the taxation of dividends and benefits.
If you have questions, contact the Experts at Henssler Financial:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166
Disclosures: The following information is reprinted with permission from Forefield, a division of Broadridge Financial Solutions, Inc. This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
