By Alina Parizianu, CFP®, MBA, RICP®
Most people don’t like to think about life insurance coverage.
However, in the event of your death, having it can mean your family will be taken care of financially.
Proper life insurance coverage can eliminate concerns about money and finances as loved ones grieve your death. Even modest funerals involve a considerable outlay of money. When there is no life insurance policy to cover these expenses, it might force loved ones into alternative means of paying for their final expenses such as asking family members for assistance, financing the cost through the funeral director, or even starting a “Go Fund Me” page.
Life insurance can be confusing, but that is not a reason to skip this important coverage. Some key considerations:
What exactly is life insurance, and how does it work? Simply put, life insurance is a contract between you and the insurance company. You make regular premium payments to the insurance company and, when you die, it pays a benefit to your loved ones which can help replace income or pay off debt.
With many different types of policies available, how do you know which one is right for you? You might be covered by life insurance provided through your employer, known as group life insurance. This is life insurance that you purchase as part of a group — typically through your employer — as part of your benefits package, or through a member organization. These insurance plans offer relatively affordable premiums because employers and large organizations can purchase in bulk. Some employers provide term coverage equal to 100 percent of a worker’s salary at no additional cost to the employee.
Although group life might not provide the comprehensive coverage you want, it can be an easy, cost-effective way to start or supplement your life insurance protection.
Keep in mind that in most cases, you will lose your life insurance plan if you leave your current employer. Some group life insurance is portable, meaning that if you leave your job, you can take your coverage with you. Be sure to ask about this.
Even if you are receiving group coverage from your employer, ask yourself: Is this group coverage enough for me and my family? You might want to consider separate life insurance coverage from your employer. But keep in mind that life insurance products for groups are different from those for individuals.
Understanding the main types of life insurance
There are two major types of life insurance: term and whole life.
Term life insurance is the simplest form of life insurance. It pays only if death occurs during the term of the policy, which is usually from one to 30 years. Most term policies have no other benefits.
The two basic types of term life insurance are level term and decreasing term. With level term, the premiums and death benefit remain the same throughout the length of the policy. Level term policies typically last 10, 20 or 30 years. Your beneficiaries receive a lump sum payment if you die during the policy’s terms. If the term ends before you die, your policy expires and you will have a few choices: go without life insurance, purchase a new level term policy, or convert your term policy to a permanent life insurance policy.
As the name suggests, with decreasing term, the death benefit drops — usually in one-year increments — over the course of the policy’s term, but your premiums remain the same. This type of policy usually lasts between five and 30 years and pays a benefit if you die during that time. Most people purchase decreasing term life insurance to cover a debt such as a mortgage or a business loan. The benefit will pay the balance of your loan in the event of your death.
Whole or permanent life insurance pays a death benefit whenever you die, no matter how old you are. Because of the number of variations, it can be a bit confusing to figure out which type might best suit your needs. There are three main types of whole life or permanent life insurance — traditional whole life, universal life, and variable universal life — and there are variations within each type.
Traditional whole or permanent life insurance provides lifelong coverage and includes an investment component known as the “policy’s cash value.” You pay fixed level premiums to the insurance company that are divided into three portions. One part goes to the death benefit; another part goes to cover the insurer’s operating costs; the remainder goes to the cash value account. The cash value grows over time in a tax-deferred account. You have the option to borrow money against your policy or redeem the policy for cash. If you borrow against your policy and don’t repay the loan, you’ll reduce your death benefit. If you surrender your policy, you’ll forfeit your coverage.
Whole life insurance might seem more complicated than term life insurance, but it’s actually the simplest type of permanent life insurance to understand: your premium remains the same for as long as you live, the death benefit is guaranteed, and the cash value account grows at a guaranteed rate.
In the 1970s and 1980s, life insurance companies introduced two variations on the traditional whole life product — universal life insurance and variable universal life insurance. Universal or adjustable life insurance is more flexible than whole life insurance. If you pass a medical examination, you might be able to increase the death benefit.
This type of policy also includes a savings vehicle called a “cash value account” that generally earns an interest rate similar to a money market account. Once you have accumulated enough money in your account, you have the option of altering your premium payments. This feature might be helpful if your economic situation changes. But you need to be mindful that if you use up all your savings accumulation, the policy might lapse, and your coverage will end. Speak to your insurance agent before altering your premium payments.
Variable life insurance combines a death benefit with a savings account that you can invest in stocks, bonds, and money market mutual funds. The value of your policy might grow more quickly, but you also have more risk. If your investments do not perform well, your cash value and death benefit might decrease. Some policies, however, guarantee that your death benefit will not fall below a minimum level.
Variable universal life insurance includes the features of variable and universal life policies. You have the investment risks and rewards characteristic of variable life insurance, combined with the ability to adjust your premiums and death benefit that is characteristic of universal life insurance.
When considering a life insurance plan — for yourself or to supplement your employer’s insurance plan — shop around to find the best rates for you and your family.
Remember that life insurance is designed to replace your income if you die. A financial planner will be able to help determine the appropriate amount of coverage depending on your age and income.
Life insurance should be part of your overall financial plan.
This article is not intended to be financial advice. The promotional content is for informational purposes only; you should not construe the promotional content as legal, tax, investment, financial or other advice. Please consult your financial advisor regarding your particular financial situation.
Alina Parzianu,CFP®, MBA, RICP® is a Financial Planning Specialist at MMBB Financial Services. Prior to joining the MMBB staff, Parizianu spent 14 years in the financial services industry, including as vice president and credit portfolio manager for a major European investment bank in New York. She holds the CFP® certification, an MBA, and a behavioral financial advice certificate.