An Introduction to Life Insurance

An Introduction to Life Insurance – at www.ZeekBeek.com

What is life insurance?

Life insurance is a special type of insurance that will make a payment to your loved ones when you die. 

Does everybody need life insurance?

Not necessarily.  Life insurance is important if you need to provide for loved ones after your death and don't have enough other assets to take care of them.  For example, a working person who is supporting a young family and doesn't have a lot of savings may need life insurance to provide for his or her spouse or minor children.  Sometimes people need life insurance for other special reasons, but this “wage replacement” is probably the most common reason.

How do I get life insurance?

Some people can get life insurance through their employer.  If not, then you need to apply to buy a life insurance policy from a life insurance company.   You should check to see if you are a member of a group (like a union or a veterans or professional association) because it may be cheaper to buy a life insurance policy as a group member.

How much will my loved ones receive when I die?

The life insurance policy will state the amount of the payment your loved ones will receive (called the "death benefit" or “proceeds”). 

How much will it cost?

That is a complicated question!  The payments you make to buy life insurance are called "premiums."  The amount of the premiums depends basically on three things: (i) the amount of the death benefit, (ii) your age and health, and (iii) the way the life insurance policy is structured.  Let's take these in turn.  First, as you would expect, insurance costs more if the death benefit is bigger--so it costs more to buy $1 million of insurance than $100,000.  Second, it also costs more to buy insurance when you are older than it does when you are younger, because your risk of death is statistically greater when you are older.  The same is of course also true if you are not in good health.  Finally, the structure of the life insurance policy plays a role in cost as well.  That can get technical, but for some more information, read on!

Are there different types of life insurance?

Insurance companies have many different names for their life insurance products, and many different types of policy structures.  But really there are only two basic types of life insurance: term and cash value.

What is term insurance?

Term insurance is insurance that just pays a death benefit if you die during the year.  You can buy term insurance that is automatically renewable, which means that as long as you pay the premium each year, the insurance cannot be cancelled –even if you become ill.  Term insurance is usually the cheapest type of life insurance.  But term insurance usually gets much too expensive to continue after you reach about the age of 72.   That is because the term insurance premium is directly tied to your statistical risk of death during each year, and that risk goes up as you get older. So if you want to buy insurance that you can continue beyond that age, then you will probably need to buy a cash value policy. 

What is a cash value policy?

A cash value policy is a policy that builds up cash value "inside" the policy and also pays a death benefit. So, actually, a cash value policy is really just a term policy plus a cash value fund.  It is important to understand that the cash value fund will be less than the amount of the premiums you pay, because part of those premiums must go to cover the risk of your death during the year-- essentially, that is the "term" part of the policy.  There are many different names for cash value policies: whole life, universal life, variable life, permanent life, etc.  That's because there are a lot of different ways to structure a cash value policy.

What is an example of one way to structure a cash value policy?

 A cash value policy could be set up so that if you pay the same premium amount every year for your life, your loved ones will be guaranteed to receive a certain death benefit, for example $100,000, when you die.   A lot of "whole life" or “permanent” insurance is set up that way.  That is probably the simplest and most common type of cash value policy.  Basically, the cash value fund that builds up inside the policy compensates for the increased risk of death as the years go by.  That makes it possible to keep the insurance going for your whole life without paying huge premiums as you get older, which is why it is often called "whole life!"

As noted, there are other ways to structure cash value policies – this is just one example.  It can be a technical and complicated area. 

Can I control the investment of the cash value fund inside the policy?

Under some types of insurance policies you can do that.  You will usually have a choice of a number of mutual (stock/bond) funds.  That type of policy is called "variable" because you can vary the investments.  Usually a variable policy is also universal, that is, it permits you to pay different amounts of premiums in different years, provided that you always pay a sufficient premium to keep the policy in force.   

Can I use the cash value fund inside the policy during my lifetime?

Yes, under some types of policies you can use the cash value fund during your lifetime.  Depending on how much cash value is built up, there may even some benefits to doing that.

What happens if I stop paying premiums?

If you stop paying premiums your policy will expire and you will no longer have life insurance, unless you have a cash value policy which has enough cash value built up inside the policy to continue the policy.

Is there income tax when my loved ones receive the death benefit?

No, the death benefit will not normally be subject to income tax. 

Is the life insurance part of my taxable estate?

Yes, if you own a life insurance policy on your own life the proceeds will be part of your taxable estate at death – even if those proceeds are payable to others, such as your children.  However, this should not be of concern unless you have a very large taxable estate (in excess of $1 million).  If it is a concern an estate planning attorney can help you take steps during your lifetime to prevent any estate tax problems – for example, by arranging for the transfer of the policy to a trust for the benefit of your loved ones.

Disclaimer – Blog Not Legal Advice

This blog is not legal advice and no attorney-client relationship is formed.  The information and materials on this blog are provided for general informational purposes only and are not intended to be legal advice.  The law changes frequently and varies from jurisdiction to jurisdiction.  Being general in nature the information and materials provided may not apply to any specific circumstances.  Nothing on this blog is intended to substitute for the advice of an attorney.  If you require legal advice, please consult with an attorney licensed to practice in your jurisdiction.