As one of the pillars of personal finance, life insurance deserves consideration by every household, especially if you're an adult with a house, a spouse, kids, or any financial liabilities. Purchasing a life insurance policy is one of the most important financial decisions you can make.
One of the most emotionally challenging experiences can be losing a parent or partner, and adding the financial aspects of that loss can seem unbearable. In one way or another, we will all experience losing someone we adore, which makes life insurance universally applicable.
Whether it may be caused by complexity or preference to avoid the topic, it's always better to be armed with the right information regarding life insurance before getting one. Read on to learn more about life insurance policies.
Varieties
There are many types of life insurance policies to choose from when it comes to life insurance. However, the two most common types of life insurance are term (lasts a specified period) and whole (lifetime or permanent).
Term life insurance bases the premium on the probability that the insured will die within a stated term, typically 10 to 20 or 30 years. Because the policy doesn't have a cash value until you die, it is more affordable than whole.
Consider it when your kids are growing up or for the length of your mortgage. Whole life insurance is more expensive, with a smaller death benefit.
However, it lasts for your entire lifetime and accumulates cash value as time goes. Consider permanent coverage for burial expenses or income replacement for a spouse.
A Contract
A policy is a contract between a life insurance company and someone (or sometimes, something, like a trust, who has a financial interest in the life and livelihood of someone else).
In the event of death, the insurance company pools the premiums of policyholders and pays out claims or death benefits. The four primary roles in a life insurance policy are the insurer, policy owner, insured, and beneficiary.
Not an Investment
Term life only provides a death benefit for a defined period and doesn't build a cash value. You pay monthly premiums for the policy's duration, and you get nothing back because you didn't die. This scenario makes life insurance only a risk management tool product.
Some brokers will stress that it's an optimal investment (because the policy has a cash value that can grow over time) to convince you to buy whole life insurance.
Although some policies have an investment feature that can offer a degree of tax privilege, it's better to put your money in the market or another real investment.
The DIME Method
Many experts recommend 10-15 times of your income when it comes to the size of your policy. However, a more personalized way to determine the costs you'll leave behind is by using the DIME Method.
According to Michael A. Lucy of Funeral Funds of Michigan, DIME stands for the following.
- D- Debt (mortgage, credit cards, etc.)
- I- Income Replacement (your loved ones would need to continue living a similar lifestyle)
- M - Mortality (funeral costs and other expenditures associated with end-of-life)
- E- Education (the price to put your children from daycare to college)
Aside from the DIME calculation, there are many online available tools that estimate your needs, like an online calculator from Life Happens. Enter all your information in the form, and it will instantly calculate your life insurance needs.
Naming a Beneficiary
When you buy life insurance, you name a beneficiary or the person or entity who receives the death benefit or proceeds of your policy should the unthinkable happen.
Name more than one beneficiary to avoid going through the painful process when your beneficiary passes before you. Also, avoid naming a minor child because they may not be able to receive the funds.
Additionally, naming your estate could also have tax implications. If the policy is to benefit your business, consider having a formal plan in place regarding how your proceeds should be used.
Conclusion
It's no shocker that some people don't like talking about life insurance because they often equate it to death. However, knowing the right information and planning for an expected death can be very helpful.
When you're ready to purchase life insurance, find someone with your best interests in mind to give you financial advice and guidance through the process.
