Coming to Grips with Life Insurance

Coming to Grips with Life Insurance Life insurance is one of those things you know you should pay more attention to, but can never seem to get around to doing. Part of the reason is an unwillingness to deal with our own mortality. But the vast array of insurance choices also makes it difficult to make decisions. To help overcome these obstacles, consider these points:

Do you really need life insurance?
The most common reason for purchasing life insurance is to ensure your family can maintain their standard of living after your death. Generally, your life insurance needs will be highest after you start a family and will decrease over time as your children grow and become independent.

However, life insurance can also serve other important purposes. If a major portion of your estate consists of illiquid assets, life insurance can provide funds for heirs to pay estate taxes without liquidating those assets. Even though the estate tax is scheduled to be repealed in 2010, it will be reinstated in 2011 unless further legislation is passed. You may also want to leave a large inheritance to heirs or a charitable contribution through life insurance proceeds. Business owners often use life insurance to buy out a deceased partner's heirs or to provide funds to pay estate taxes so the business does not have to be sold.

How much life insurance do you need?
Various rules of thumb exist, such as purchasing five to seven times your current income, but they don't consider your personal situation. The amount of life insurance you need depends on your current net worth, the lifestyle you want to provide for your family, and other personal needs and desires. See the article "How Much Do You Need?" for more details.

What type of insurance should you purchase?
There are two basic types - term and permanent. Term insurance provides protection only, with none of the premium set aside to build cash value. If you die during the policy's term, your beneficiary receives the policy's proceeds. However, you get nothing if the policy is canceled.

Permanent insurance accumulates, from premiums paid and investment earnings, a cash surrender value that is returned to you if you surrender the policy. Also, you can borrow the cash value through policy loans, although outstanding loans reduce the insurance proceeds when you die.

Carefully assess which type of insurance is preferable for you. When you are younger, term insurance premiums tend to be lower. However, the premiums typically increase over time. If you are insuring a need that is likely to go away, such as providing a standard of living for minor children, then term insurance may be more appropriate. Those insuring a permanent need, such as providing funds to pay estate taxes or to maintain a standard of living for a spouse, may want to consider permanent insurance.

How do you compare individual policies?
Since life insurance companies offer so many different options, it can be difficult to compare several policies. Try following these steps:
  • Compare only the same type of policy. For instance, don't compare a term policy to a variable life or whole life policy.
  • Make sure the policies contain the same options and riders.
  • If considering permanent insurance policies, review the assumptions used in the policy illustration, which shows the policy's projected value at some time in the future. Keep in mind that these illustrations are hypothetical and your value will depend on the policy's actual performance. Obtain illustrations based on three alternatives - the original illustration, one with an interest rate 1% lower than anticipated, and one with the minimum guaranteed rate.
How do you assess the insurance company's financial strength?
Since you may not receive benefits for many years, you should assess the insurance company's financial strength before purchasing the policy and periodically thereafter. A good place to start is with the ratings assigned by rating organizations, reviewing the ratings of at least two organizations. Familiarize yourself with each organization's rating systems, since the same grade from different organizations can mean different things.

A life insurance policy should be a long-term commitment, so spend the time up front to ensure you purchase a policy that adequately meets your needs.

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