Why do people buy life insurance? Most often, it’s used to replace income for dependents who rely on others for their basic financial needs. It’s also used to create an inheritance for beneficiaries, even if there are few other assets to pass on. But there are a number of other strategic ways people use life insurance that go beyond protecting loved ones. Life insurance products can be complicated, so let’s start with some of the basics to help clear things up.
There are two major types of life insurance: term and permanent. Here’s a closer look.
Term life insurance
Term life is the simplest and generally least expensive form of life insurance. It is mainly purchased to protect people who depend on someone else’s income for their basic living expenses. The most common example is parents with young children.
Term insurance is purchased for a specific amount of time—usually 10 to 30 years—and the death benefit is only paid if the policyholder dies during the insurance term. If you die during the coverage term, your beneficiaries could use the death benefit to help pay off a mortgage or other debts, fund college or simply maintain their lifestyle after you’re gone. The death benefit is typically paid in a lump sum that is generally free from federal income taxes.
If you’re concerned about your family or other people you care about struggling financially if you died unexpectedly, term life insurance can be a cost-effective solution.
Term coverage is generally more affordable than other types of coverage. Premiums typically stay the same for the duration of the coverage, but they may jump significantly if you continue coverage beyond the initial term.
If you’re concerned about your family or other people you care about struggling financially if you died unexpectedly, term life insurance can be a cost-effective solution.
Permanent life insurance
Permanent life is different in that it provides coverage throughout the insured’s lifetime—not just within a specific term. This type of insurance comes in three categories—traditional whole life, universal life and variable life. It can seem complicated and expensive, but the additional features and costs may help people solve for what they want to achieve.
Permanent life insurance is designed to cover you for the rest of your life. While it can also help protect beneficiaries if you die unexpectedly, permanent coverage can also be used to help transfer wealth or provide funding to ensure business continuity. The proceeds of life insurance typically pass to your beneficiaries free from federal income taxes. Some permanent insurance also accumulates cash value you can access through loans and withdrawals if you need it.
There are different categories of permanent insurance, but we’ll focus on “universal” life insurance. Universal life insurance typically offers flexibility to increase or decrease your premiums and coverage amounts throughout your lifetime. Depending on the product, universal life insurance can have differing goals. Some products are focused on accumulating cash value, and others are focused primarily on guaranteeing a certain death benefit.
Cash-accumulation-focused policies
Cash accumulation policies can provide not only death benefit protection, they are also designed to accumulate “cash value” over time that can be accessed later. The cash value grows tax-deferred and, depending on the policy, can be accessed for things like college expenses, funding a business or even covering a retirement income shortfall.
Death-benefit-focused products
If your primary focus is maximizing the death benefit that passes to your beneficiaries, these products can provide a death benefit that is guaranteed not to lapse—as long as premiums are paid as illustrated—regardless of interest rate changes or other factors that are outside of your control. As with other life insurance products, the death benefit is generally passed to beneficiaries free from federal income taxes.
With its guarantees and flexibility, permanent life insurance is typically more expensive than term insurance. But in exchange for higher premiums, you can receive lifetime coverage and the death benefit proceeds can help you leave a legacy to loved ones, leave money to charities, fund the transfer of a business to a partner or family member, and even help cover estate taxes or final medical bills.
Talk to a professional
This is a high-level overview of life insurance, and products and features will vary by company. Even term insurance can be a long-term purchase, so it’s important to know exactly what you’re buying. Make sure you fully understand the benefits and costs of any life insurance product before making a decision. Talk to an insurance professional to help you decide what kind of insurance is right for you.
