insurance

Why life insurance should matter to you

Lisa GardnerOn many days, we may feel immortal -- although never, of course, on Monday mornings. But the unpleasant reality is that all of us will die someday.

Purchasing life insurance is among the best ways to provide for our families after we are gone.

Knowing why you want to purchase life insurance can help you determine how best to do so, says Lisa Gardner, resident expert on insurance and associate professor of statistics at Drake University in Des Moines, Iowa.

Life insurance is a product that sometimes confuses and intimidates people. In a nutshell, who needs this insurance, and who does not?

All life insurance policies provide a death benefit, which is simply a sum of money paid to the insured's designated beneficiaries (those you chose to receive the money) when the insured person dies. If you are the insured, you can determine who gets the money, with very, very few restrictions. Reasons why your beneficiary might need money when you die include the following.

  • They need to pay for your funeral and burial costs.
  • They need money to pay for your estate and inheritance taxes.
  • They depended on your income to make ends meet. Now that you are gone, they need another source of money to help pay the bills.
  • They depended on your ability to generate income for their business.
  • They were a creditor to whom you owed some money.

Another reason for buying life insurance protection is simply because you want to give someone money when you die.

Policyholder dividends constitute another, but less significant, benefit associated with some life insurance contracts. Policyholder dividends, which represent refunds of excess premium payments, cannot be guaranteed by insurance companies, and typically they won't be paid until the policy has been in place for a few years. Depending on the policy, these can range from a few dollars to more than a few hundred dollars each year.

Some life insurance policies include savings elements called "cash surrender values," which should build over time. The interest income earned on savings while the policy is in force accrues federal-income-tax-free in the U.S.

Life insurance basically can be divided into two types: temporary, or 'term,' and permanent. Do you have some tips for determining which product is right for you?

Determining whether to buy term versus permanent insurance comes back to deciding for what purpose you are buying insurance. While cost is important, don't let it be the only thing you consider when choosing between the two types of insurance.

Temporary, or "term," insurance is fundamentally a "you die, we pay" product. You buy this to provide money to pay for funeral and burial costs, estate and inheritance taxes, debts, or (provide cash to) businesses that rely upon you to generate income for them. You also buy it to ensure that those you leave behind have adequate income to maintain the standard of living that they had before you, an income earner, died. Or, you buy it to leave money to the people or organizations you care about.

These are the same reasons why you buy permanent life insurance, which includes a savings element called a "cash surrender value." Unlike term insurance, permanent insurance has a tax-protected savings element, and thus, also serve(s) as a savings/investment vehicle with favorable income tax treatment.

How can people best determine the amount of coverage they need?

The amount of coverage that you need depends on why you are buying life insurance. If the purpose is to provide cash to pay for your burial expenses, then you won't need as much as if the purpose is to replace, say, a $50,000 annual income, or pay off many mortgages.

Once you determine why you want to buy coverage, then it's easier to determine how much you need. If you are good in math, you can do some present value/future value calculations to determine how much coverage to buy.

Or, you can simply ask someone who is very knowledgeable about life insurance income replacement needs to help you. Talk to a licensed financial planner, preferably someone who has passed professional exams beyond what is required by your state. These exams include Chartered Life Underwriter, Chartered Financial Consultant, Certified Financial Planner and Chartered Financial Analyst, to name a few. Most university professors of risk management and insurance can help with this task, too.

Do single people need life insurance?

Absolutely. The reasons that I mentioned in response to your first question don't just apply to those who are married or partnered.

Once the children have flown the nest, does it make sense to drop life insurance? What are the benefits and risks of doing so?

Again, you need to know why you want to have life insurance in place. If the only purpose is to pay for the costs of raising your children in the unlikely event that you die before they are grown, then yes, you should drop it once they have left the household.

You will save some money in dropping your life insurance. That's an upside to quitting or, in insurance-speak, "surrendering" your policy. If the contract has a savings element, you will be taxed on the policy's investment gain when you cash it in after the kids are grown. That's a downside to policy surrendering.

But there are many other uses for life insurance as I mentioned earlier. Be clear about what life insurance can and cannot do for you before buying a policy, and before surrendering one, too.

We would like to thank Lisa Gardner, resident expert on insurance and associate professor of statistics at Drake University in Des Moines, Iowa, for her insights.

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