Shopping around for life insurance can seem overwhelming. After all, you're not just thinking about the future, but you're thinking about a future without you in it. How can you buy life insurance and plan for that grim eventuality? The first step to making this important decision is sorting out your priorities. There are several factors to consider when discerning what type of life insurance policy is best for you and your loved ones.
What to look for in a life insurance policy
Determining the costs you'll leave behind is a difficult but necessary step. You should consider any debts you have, including mortgages, student loans, and credit cards. Income replacement and educational expenses for your spouse or other dependents should also be considerations. Additionally, consider how much it will cost to cover your funeral or memorial arrangements.
How long do you need to be covered?
You'll also need to decide how long you’re going to need coverage. This period is known as the term length. For example, it could be the length of your mortgage or just until your children reach age 18. If you die in this period, it can be used to pay for things such as burial expenses and income replacement for a bereaved spouse.
Who will be your beneficiary?
A life insurance beneficiary is the person or entity who receives the proceeds of your life insurance policy once you're gone. You should probably avoid naming minors as beneficiaries because children can't usually receive funds. Instead, choose a trusted guardian or establish a trust to distribute funds. Also avoid naming your estate as a beneficiary, which can lead to costly tax implications. If the entity is your business, have a formal plan in place as to how those funds will be used toward the business.
What's the difference between term and whole life insurance?
There are two major types of life insurance: term and whole life. Though there are various subtypes within those as well, term and whole life are the two main categories. They are differentiated by several important factors.
What is term life insurance?
Term life insurance pays only if death occurs within the term of the policy. These terms are usually from one to 30 years and that’s it. There are two types of term life insurance; level term and decreasing term. Level states that the death benefits remain the same throughout the duration of the policy. Decreasing means exactly what it says, the benefit drips, commonly in one-year increments, over the course of the term itself. There are usually no other benefit provisions attached to term life insurance.
What is whole life insurance?
Whole life or permanent life insurance pays a death benefit whenever you die and does not expire unless the policy holder sells the policy or lapses on payments. However, there are some provisos attached to whole life insurance, especially when you get into the different subcategories. There are three major types of whole life or permanent life insurance. These types are traditional whole life, universal life, and variable universal life.
Traditional whole life means that the death benefit and premiums are meant to stay the same throughout the life of the policy, however long that may be. This would be the best option by far, if not for the fact that the cost per $1,000 of the death benefit increases as the person ages. The older you are, the more you pay.
Many insurance companies offset these potentially back-breaking costs in later years by charging a higher premium in early years so that they can invest that extra amount and use it to supplement the level premium payments in a person’s later years. These payments are available to the policyholder as a cash value once they reach a certain amount, in the event that they decide not to continue the original policy.
Which type of life insurance is better?
It’s difficult to say which policy might work for you. In the end, you will have to look at the pros and cons of each. Whole life insurance may cover you for longer, but it is far more expensive to manage over time. Term life insurance is more affordable, but does not seem to cover you should you live past the 30-year limit.
How does age impact life insurance rates?
Age is perhaps the most important factor influencing your life insurance premium rate. The older you are, the higher it is when you start, and it increases every year. The average annual increase for a premium is 8–10 percent. The increase can be as low as 5 percent if you’re in your 40s and as high as 12 percent if you’re 50 or older.
Is a medical exam required for life insurance?
Life insurance plans usually require a complete medical exam, also known as a paramedical exam, before a policy is awarded. This standard physical is used to confirm the health details you provided when taking out the life insurance policy.
Life insurance companies make their decisions based on the likelihood of you dying. Therefore, if you're older, sick, or in poor health, information revealed in your paramedical exam could affect your premium, eligibility, and insurability.
Can life insurance policies be used as savings?
Some permanent life insurance policies can be used as a way to set up a savings account. Because most life insurance policies are lifelong, their value is meant to increase over time. Since that amount grows on a tax-deferred basis, it's considered an asset in your financial portfolio. Whole life insurance policy holders can also borrow against their death benefit. If they die before repaying the amount, the outstanding amount is deducted from the benefit before distributing the amount left (if any) to beneficiaries.