Individuals and small-business owners typically buy life insurance as a safety net for their families. Insurance policy payouts can cover mortgage, tuition and other expenses, especially for young families with dependent children. Life insurance coverage should be part of overall financial planning, which should include assessing current and future cash flow needs. Term life and cash value life are the two basic types of life insurance coverage.
Term life insurance covers the policyholder for a specific period at a relatively low cost. The beneficiary receives payouts if the policyholder dies during the coverage period, but not if he lives beyond it. Depending on how the policy is written, the policy payouts could be the same over the coverage period regardless of when the policyholder dies, or the payouts could increase or decrease over the coverage period at a scheduled rate. Policyholders can sometimes renew and convert term life policies without having to undergo new medical examinations and regardless of their current medical condition. The convertible feature allows a policyholder to exchange a term life policy for a permanent life policy. The renewable feature allows a policyholder to extend the policy for additional terms. Term life insurance is affordable, but it has no investment component and premiums increase with age.
Cash Value Life
Premiums for cash value life insurance are higher than term life because the coverage includes an investment component in addition to death benefit payouts for the beneficiaries of policyholders. The cash component can be withdrawn, reinvested or used as collateral for loans during the policyholder's life. However, insurance companies may place restrictions on the timing of cash withdrawals and the termination of policy coverage. The two main types of cash value life insurance are whole life and universal life.
Cash Value: Whole Life
Unlike term life coverage, whole life covers a policyholder for her entire life. The premiums are usually higher than term life insurance policies because part of the premium accumulates as investment. Some whole life policies require premium payments for a set number of years, while others require payments over the policyholder's lifetime. The main advantage of whole life insurance coverage is that it forces the policyholder to save a certain amount of money every year, which grows over time and can serve as collateral to secure loans. The disadvantages include not accumulating enough cash value during the first few years and restrictions on cash withdrawals.
Cash Value: Universal Life
Universal life insurance gives policyholders the flexibility of deciding how much to put into the cash component, over and above a minimum premium. The additional payments go into a cash-value account, which can offset future policy premiums or accumulate as an investment. The insurance provider usually manages the investments, although some universal life policies -- known as variable universal life policies -- allow policyholders to choose their own investment products, such as stocks and bonds. The advantages of universal life policies include flexibility and the possibility of higher death benefits if the investments perform well. The disadvantages are similar to those for whole life insurance policies.
Other types of life insurance include group life and credit insurance. Businesses may offer life insurance to employees under group policies and some may subsidize part of the premiums. Group insurance premiums are usually less than comparable individual insurance premiums. Lending institutions may require a borrower to buy credit insurance to cover the outstanding loan balance in case illness or death prevents him from making loan payments.
The amount of life insurance coverage needed depends on the age of the policyholder, the number and age of dependents, and existing assets and liabilities. People should buy insurance from financially sound underwriters that have a long operating history and have solid ratings from A.M. Best, a rating agency for insurance companies, or other rating services.
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