Buying a Life Insurance Policy

Life insurance is a key component of holistic financial planning and one of the most important purchases many families make throughout their lives. Buying life insurance not only provides families with a peace of mind but also the means to achieve the future dreams of all family members.

There are a number of considerations when shopping for a life insurance policy. Which company to use, the type of policy, and the amount of insurance to purchase; these are some of the more obvious decisions that need to be made. There are a number of subtle aspects that should also be considered when purchasing life insurance.

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Which Life Insurance Company is Best?

Most U.S. insurance companies have been around for over a hundred years, while those that haven’t are typically a co-insurer or smaller division of a long standing brand. Few industries have endured the markets, economic conditions, and political changes over the years as insurance companies have.

When choosing a company to do business with, there are simply two important factors for consideration. First, the company should offer the type of policy needed that will satisfy all the practical needs of the family or entity purchasing the insurance. Second, the insurance company should be financially sound and have a reliable claims-paying ability. When it comes time to pay up, they should be around and have the cash to honor policies – that’s the most critical piece of this mechanism.

There are a number of independent rating agencies that provide information regarding the financial strength and the claims-paying ability of insurance companies. AM Best, Moody’s, and Standard & Poors are a few of the more prevalent names of such agencies. Their research and performance ratings help consumers make the choices about which companies to trust and which to avoid.

How Much Life Insurance to Buy?

The grandparents of current working families may have purchased life insurance in the amount needed to cover final expenses. The next generation purchased enough to get the family out of debt (pay off any mortgage) plus the final expenses. Though these efforts helped curb financial issues, the unexpected passing of the bread winner typically meant major changes for the future of the family.

In the event of an unexpected death, a family should consider what they want to give up. For example, if the sole income provider for a family with children passes consider the following scenarios:

     
  • Will the remaining spouse be able to enter the workforce and replace the lost income?
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  • Is paying for 100% of college expenses for all children still a goal?
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  • Does this create a shortfall in retirement savings or compromise plans for the remaining spouse?
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  • Did the deceased run a business that simply cannot continue operations without his or her presence?
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  • Do we want to preserve assets or create a legacy for our family?

These are just some of the factors that need consideration when determining the amount of insurance a family needs. Equally important, and a heavy factor in helping determine the type of insurance to purchase, is the budget and financial strength of the family. Another factor in determining the amount of in surance needed is the time value of money. For example, money for college, retirement, and bereavement is not all required immediately following a death. There will be some time and opportunity to make investments and grow the money received from a death benefit. Financial planners will assist with the calculations and forecasting.

Choosing the Type of Life Insurance Policy

The type of insurance policy a family chooses will be determined by the amount of insurance needed, budget, and the goals intended for the purchase. Essentially, there are three different types of insurance policies. They are term life insurance, whole life insurance, and universal life insurance. Within universal life insurance are a number of options for investments and policy features, so this category is broader than the others.

Term Life Insurance

Term life insurance is pure insurance for a specific period of time. As an example, $100,000 twenty year term would be a $100,000 death benefit for a period of twenty years, after which the policy would be terminated. Term insurance will have the lowest premiums for a set amount of life insurance when compared to whole and universal policies. Term insurance has no cash value, though some policies may offer the option to convert to whole life insurance policies which may have a cash value.

Term insurance should be considered in circumstances when there is a tighter budget, such as younger families and newlyweds just getting their start in life. Term life also makes sense in business situations where large amounts of insurance are necessary to protect partners from being left with a crippled business.

Whole Life Insurance

Whole life insurance is a policy with a fixed death benefit and premium structure designed to mature (where the cash value equals the insurance face value) near age 100. Each premium payment is split to pay for the ‘pure’ insurance as well as accumulate in a cash account. As the cash value grows the gap between the death benefit decreases, thus requiring less ‘pure’ insurance and expense.

Whole life policies are a sound choice for families that need some protection now as well as want to supplement retirement savings. Because there is an accessible cash value, funds within the policies can be utilized later in life when the need for insurance has faded. Tax free loans from the policy may be available, otherwise direct withdrawals (consider tax consequences!) can be made.

Universal Life Insurance

Universal life policies are the most flexible type of insurance. There is substantial flexibility with the amount of insurance, the premium amount and frequency, the investment holdings within the account, as well as with any withdrawals from the policy. To demonstrate some aspects of the flexible nature, consider the following examples. If the investments in a universal policy perform exceptionally well, the owner may be able to refrain from paying premiums during the market gains. Also, in a policy where investments perform poorly the amount of insurance (death benefit) can be reduced so premiums don’t necessarily increase.

Universal policies make sense for more financially stable families, those which may already max out retirement savings and still have excess cash flow. Small business owners or high income families can utilize UL’s as a retirement saving tool similar to a Roth IRA. These policies are ‘universally’ flexible and are also used for wealth preservation and legacy creation.

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