Don’t know much about life insurance? You’re not alone. Most people, unfortunately, miss this important step until it’s too late! We don’t want that to be your story. This article was written to help you learn and understand why life insurance is such a crucial part of your financial plan and why you should get it today!
Let’s look at a fictional scenario of two millennials. In their early years, Linda and Joe were skeptical about life insurance. They were both young professionals just starting their respective families and did not understand why purchasing a life insurance policy was such a pressing matter. However, Linda decided to visit her local insurance company to learn more. Well, Linda ended up purchasing a 20-year term life insurance policy and when she passed on unexpectedly, her family was financially stable years later. They used the death benefits from Linda’s life insurance to cover their expenses while they mourned the loss of a loved one.
Joe ignored life insurance, and in an unfortunate twist, lost his life. Suddenly, his family had to deal with his untimely death. If Joe had taken a life insurance policy, the family would not have felt the financial burden of lost income nor the burden of the other debts he accumulated. If you don’t want to let your dependents deal with the consequences of Joe’s actions and want them to be financially secure in the case of your premature death, then you should take the initiative to learn more about life insurance.
What is life insurance?
Life insurance is a contract between you and the insurance company. In exchange for monthly premiums, the insurance agrees to pay out a lump sum to your beneficiaries upon your death. The lump sum is most commonly known as the death benefit. In most cases, the death benefit is transferred to the beneficiaries tax free.
In a life insurance policy there are four distinct players. The insurer, the owner, the insured and the beneficiaries. In the case of Linda, the company she paid the premiums to was her insurer. She was both the insured and the owner of the policy while her family was the rightful beneficiary.
So why do you need life insurance?
The main goal of acquiring life insurance is to make sure that once you pass away, your dependents will have a source of income for years to come. In short, your death will not place a financial burden on them as the death benefit can be used to pay for a plethora of things. It can be used to pay for funeral and burial expenses as well as ongoing monthly expenses. Another way the money can be used is to settle all the pending debts at the moment of your death. If you had a car loan or mortgage, it can be used to pay them off and save your family from assuming unnecessary debts.
If you have a running business, the death benefit can be used to maintain it in case of your untimely death. The money can be injected into your business to keep it afloat and avoid bankruptcy. If you have children, the death benefit can be used to pay for future college expenses as well. As you can see, life insurance is a must if you have people who are dependent on your income! In fact, it is widely recommended that you obtain life insurance coverage that is 10-12 times your salary to cover all potential expenses your family could incur. This will remove some of stress often felt by a grieving family immediately after a loss.
Linda’s family benefited from the death benefit in many ways. They were able to sustain a normal life financially after her death. On the other hand, Joe suffered the blow of not purchasing one. His family took up the burden of settling his debts and other personal loans and struggled to pay their ongoing bills as they dealt with the reality of becoming a one income household.
Types of life insurance
There are different types of life insurance policies that you need to comprehend before deciding to purchase one. The most common policies you’re likely to come across are term life insurance and whole life insurance. Here is a quick summary of each.
Term life insurance
Term life insurance covers you for a given timeline and its rate is fixed for that period (20 years, 30 years, etc.). For example, Linda’s specified period was 20 years. When the term expires you can either renew the contract or forego the renewal.
It is also important to note that term life insurance is the cheapest and most convenient life insurance you can ever purchase. This explains why Linda bought this type. She was still young and could not afford high premiums. Term life insurance afforded her the option of low monthly premiums while obtaining a significantly large death benefit.
Whole life insurance
Whole life insurance insures you for the rest of your life so long as you continue to make the monthly premium payments. However, the monthly premium is often 12-14 times higher than term life insurance, for a much lower death benefit.
Say for example, Linda earned a salary of $50,000 annually. In this case, she would need at least $500k coverage (10 times her salary). For a healthy non-smoking 25 year-old, she could purchase a 20-year term life insurance with a death benefit of $500k for $30.45/month ($350 annually) while with whole life insurance for the same death benefit, it would cost her $415.85/month ($4,780 annually)! What a huge difference!
Whole life insurance also has a cash value component that serves as a savings or investment-like vehicle which gains value over the life of the policy. It can be borrowed against like a loan, and is paid out upon the policyholder’s death.
Benefits of term life insurance
Term life insurance can be an immediate relief to your loved ones in case of death. Although some life insurance agents argue that whole life insurance is better because of the cash savings vehicle option, term life insurance provides far more benefits. Remember, the purpose of life insurance is income replacement – not a savings account! Some benefits of term life insurance include:
- Allowing your beneficiaries to enjoy a higher death benefit, which you pay at a much lower rate compared to whole life insurance.
- Term life insurance is not taxable. Your beneficiaries receive the lump-sum amount in full.
- Did you know that the death benefit is not part of a probate estate? No third party can claim to share the benefit. This translates to prompt payment to the beneficiaries. No tedious legal process involved – just a seamless payment.
- The younger and healthier you are, the cheaper your premiums will be. The cost to insure yourself as you get older increases and so does your chance of developing different medical conditions that also adversely affect your premiums. Linda was able to afford her premium payments from a young age which would not have been the case had she purchased a whole life insurance.
Having life insurance should be part of everyone’s financial portfolio. If you have someone who is dependent on your income, this is one of the few ways you can ensure that your family will be taken care of in the case of your death without the added burden of financial stress. While the thought of having whole life insurance seems enticing, term life insurance is the better option for most! Ideally, once your term is up, you would have saved/invested enough money (the difference you’re saving between the term life insurance and whole life insurance monthly premium) to not need another life insurance policy. The financial decisions you make between today and 20-30 years from now, should put you in a position where your assets insure you and you no longer need a life insurance policy. Regardless of where you are on your journey, having life insurance is a no brainer. Tomorrow is not promised. Make the decision today to give you and your family the peace of mind that is needed knowing they would be in a good place in the event of an unexpected death. You will be happy you did so!