What is life insurance, and who needs it?

Life insurance basics

Life insurance is a contract between an individual (policy owner) and an insurance company (insurer). The policy owner agrees to pay a periodic premium or lump sum in exchange for the insurer’s promise to pay a particular sum of money (death benefit) to certain individuals (beneficiaries) upon the death of a specified person for whom the policy is purchased. The person covered by the life insurance policy (insured) may or may not be the policy owner. But, for purposes of this book, we will assume the policy owner and insured are the same.

Not only will coverage provide monetary assistance for beneficiaries who were dependent on the deceased’s income, it will also provide peace of mind. The dollars invested in life insurance will help to cover the necessary living expenses that loved ones will continue to incur after an insured’s death, which will enable prudent planning for the future. Moreover, the cash value that a permanent policy may generate can help to support insured individuals when they most need it; it will allow them to borrow funds that they have been earning rather than acquiring a bank loan to meet expenses, thereby eliminating the need for loan applications, approval, and strict repayment terms and conditions. This can prove to be invaluable when the unexpected arises – such as job loss or illness – and these dollars can provide a type of safety net for those with coverage. Life insurance is an essential component for anyone wanting to protect loved ones for the future.

There are two main types of life insurance that we’ll address in this guide – term life insurance and permanent, or whole, life insurance. Everything else is a variation of these two types. The type of insurance you need may depend on a variety of factors, including your financial situation and your lifestyle.

Term life insurance provides coverage for a specific period of time, typically from one to 30 years. The death benefit is only paid out if you pass away within the term of the policy. If the term ends before you die, you receive no return on the money that you paid for the insurance.

Permanent life insurance provides coverage for your entire life as long as you continue to pay your premiums. Along with providing for death benefits, permanent life insurance also has a cash value component. You have the option of cancelling your policy and cashing out the policy and the premiums that you have paid into the policy at any time. Alternatively, if you continue to pay the premiums, you can opt to redeem or borrow part of the cash value, yet keep the policy in effect. Permanent life insurance generally has higher premiums than term insurance.

 

Who needs life insurance?

Life insurance is generally needed any time there is a situation where an income earner is responsible for the financial needs of another. If you or your spouse provides a significant portion of the family’s income, you will need some sort of life insurance for your family to maintain their standard of living. If this individual passes away, life insurance can replace his or her income, pay to raise children, and cover their college education.

If you do not have any dependents, or are not significantly contributing to your family’s household income, you likely do not need life insurance; however, you may wish to buy a life insurance policy to cover the cost of your funeral services as well as leave an inheritance to family members.

Another factor that needs to be taken into account when evaluating your need for life insurance Policy – and what type to get – is how much debt you have accrued through mortgages, car loans, and credit cards. This is especially the case for term life insurance. Ideally, your term policy should cover the vast majority of your debts. Debt is not a burden that you would want to leave for your family to take care of since this cost is easily covered with a term policy.

Later in life, term life insurance may become less necessary or not needed at all, depending on an individual’s assets and net worth. As an individual nears retirement age, it’s often assumed he or she will have enough money in the bank to cover the cost of living for himself or herself along with any dependent.

You should consider purchasing life insurance if you fall into one of the following categories:

·         Parent. Parents are generally financially responsible for their children. In the case one or both parents pass away, the death benefit can help to cover housing, living, childcare, and educational expenses of dependant children.

·         Couple. Even if they do not have children, couples typically need coverage. For example, the primary earning partner needs insurance to ensure the financial well-being of the other partner in the case of death. Both partners may need insurance if they have significant outstanding loans and debts and to avoid depletion of the couple’s savings if one partner dies.

·         Single adult. Coverage is essential if an adult is either a single parent or the primary supporter of another individual such as an elderly parent.

·         Child. Children may need life insurance. The death benefit will pay for medical and burial costs.