ABCs of Life Insurance

Your death would result in a great emotional loss for your family. In addition, it would result in a great financial loss. While nothing can reduce the emotional loss that would result, the risk of financial loss can be reduced by having your life adequately insured. While you might find it difficult to address the topic of your death, if your family is important to you, you need to be insured.

To take charge of your financial affairs you must determine how much life insurance you will need. There are no fixed easy answers, but there is a path you can follow to create guidelines.

There are several key issues that only you can resolve:

Once you have answers to these questions, there are various was to ESTIMATE how much life insurance you may need. Your financial planner, CPA and attorney can all provide input into this process. With the dollar amount of coverage identified, you now are faced with the type of product you need.

The kind of life product you buy must be based on your particular goals and circumstances, just like the question concerning how much insurance. Years ago there were only two types of insurance: term and guaranteed permanent. This still holds true today, but there are endless variations on the theme. Let's review the difference between term and guaranteed permanent life insurance.

Term Insurance
Term insurance pays your survivor a death benefit if you die during the term covered by the contract. The policy is priced based on your likelihood of dying during the term of the contract. The variation on the theme is in the term or length of the contract and the clauses that allow you to continue the policy beyond the term. Most states allow 1-year, 5-year, 10-, 15-, 20-, even 40-year term periods. How many years the premium stays fixed or even (for example, 10 or 20 years) will determine the annual cost.

Whether you can extend the coverage beyond the term is the other variation. Most policies will allow coverage beyond the term at a guaranteed maximum rate. This rate could be as much as 100 times greater than the premium you paid previously. If you are healthy you can reapply with a medical exam and start another term; if you are not insurable you might be willing to pay that 100-fold premium knowing that the death benefit will be paid to your family soon.

Guaranteed Permanent Insurance
Guaranteed permanent insurance (AKA whole life) provides you guaranteed coverage as long as you pay fixed premiums. Because these premiums can't be increased, the insurance company must make conservative assumptions about its future expenses, investment performance and death claim experience. Premiums are normally calculated assuming an investment rate of only 4% or 5%. A "dividend" (a partial return of premiums) is paid on most policies when the company's actual performance exceeds the conservative assumptions made in setting the premiums.

The three elements of a whole life policy are: 1) the fixed premium, 2) the death benefit and 3) the cash value increase. It is the way that the "cash value" accumulation is calculated that makes the variations in whole life policies. In whole life policies the dividend is totally controlled by the insurance company and is predicated on its ability to outperform the assumptions made when the premium was established.

Universal life is a combination of term insurance with a "side fund" that returns a monthly interest rate. Premium payments are flexible with some minimum premium required to cover the term cost (cost of providing the death benefit). Each month the company deducts expenses from the premium and credits your cash value account with any investment overage expressed as an interest rate.

Variable whole life allows the insured to direct the investment overage into a menu of mutual fund type separate accounts. You are assuming a level of risk for your investment return that might or might not outperform the traditional cash value accumulation in a whole life policy.

Which type of policy is best for you is often a function of how long your need will last. Is this coverage for your family until your children graduate from high school or college? Is this to cover your 30-year mortgage? Is this to cover an estate tax burden 30 years from now? Term insurance is generally more appropriate for short term needs (under 10 years). In contrast, whole life is generally more cost-effective if your needs exceed 15 years, and either type may be appropriate for an intermediate need.

Regardless of which policy type is best, the first rule is to cover your total life insurance need. If your need is $1,000,000 and your budget is small, then buy the longest term to fit your need. There isn't a survivor who says "I have too much money to live on comfortably for the rest of my life" but there are many survivors who lament that the deceased didn't plan carefully enough to properly provide for an untimely death.

Rachel Owens is a Certified Family Business Specialist and operates TriCircle Financial Group and Succession Strategies. She offers group and individual life, health, and disability insurance, as well as retirement, estate, and business transition planning. 714-560-9022.