As a financial professional, you already know why investing is important. But occasionally you meet a client who doesn't understand even the most basic concepts and tools of successful investing. What do you say? The following is an easy to follow explanation to help you convince clients why they should invest in life insurance.

Life Insurance: The Basics

Life insurance was initially designed to protect the income of families, particularly young families in the wealth accumulation phase, in the event of the head of household's death. Today it is used for many reasons, including wealth preservation and estate tax planning. Of course, it still provides you with the opportunity to protect yourself and your family from personal risk exposures like repayment of debts after death, providing for a surviving spouse and children and fulfill other financial goals such as college funding, leaving a charitable legacy or paying for funeral expenses.

Life insurance protection is also important if you are a business owner or a key person in someone else's business, where your death (or your partner's death) could prevent the business from continuing its operation. One of the key benefits from any type of life insurance is that the death benefit that is paid out is always tax-free. All life insurance policies involve four separate parties: the insurance carrier, the policy owner who pays the premiums, the insured upon whose death the policy will pay out and the beneficiary who receives the death benefit proceeds.

Who Needs It?

Not everybody needs life insurance. If you are single and have no dependents, it may not be worth the expense. If, however, you have anyone who financially depends on you (even partially), life insurance may be appropriate for you. When considering life insurance, ask yourself the following questions:

  • Do I need life insurance?
  • How much do I need?
  • How long will I need it?
  • What type of policy makes sense for me?  

Your need for life insurance will depend on your personal circumstances, including your current income, your current expenses, your current savings and debt and your family's goals. Many planners recommend coverage equal to at least six to 10 times your gross annual income, but your or your family's needs may differ from that. You will have to compare the what you have versus what goals you'd like for your family once you are gone, keeping in mind that their security can often carry a higher price tag than you originally thought.

Types of Life Insurance

Life insurance protection comes in many forms, and not all policies are created equal, as you will soon discover. While the death benefit amounts may be the same, the costs, structure, durations, etc. vary tremendously across the types of policies.

Whole Life
Whole life insurance provides guaranteed insurance protection for the entire life of the insured, otherwise known as permanent coverage. These policies carry a "cash value" component that grows tax deferred at a contractually guaranteed amount (usually a low interest rate) until the contract is surrendered. The premiums are usually level for the life of the insured and the death benefit is guaranteed for the insured's lifetime. Any withdrawal you make will typically be tax free up to the amount of premiums you have paid into the policy minus any prior dividends paid or previous withdrawals. Because of their permanent protection, these policies tend to have a much higher initial premium than other types of life insurance.  

Universal Life
Universal life insurance resembles whole life in that it is also a permanent policy providing cash value benefits based on current interest rates. However, the premiums, cash values and level amount of protection can each be adjusted up or down during the contract term as the insured's needs change. Cash values earn an interest rate that is set periodically by the insurance company and is generally guaranteed not to drop below a certain level.

Variable Universal Life
Variable universal life insurance gives the consumer the flexibility of a universal policy along with a selection of investment choices. The mutual fund sub accounts in these policies are technically classified as securities and are therefore subject to Securities and Exchange Commission (SEC) regulation and the oversight of the state insurance commissioner. The investment risk in these policies lies with the policy owner; as a result, the death benefit value may rise or fall depending on the success of the policy's underlying investments. However, policies may provide some type of guarantee that at least a minimum death benefit will be paid to beneficiaries.

Term Life
One of the most commonly used policies is term life insurance. It pays the face amount of the policy, but only provides protection for a definite, but limited, amount of time. Term policies do not build cash values and the maximum term period is usually 30 years. They are useful when there is a limited time needed for protection and when the dollars available for coverage are limited. The premiums for these types of policies are significantly lower than for any type of cash value policy. They also (initially) provide more insurance protection per dollar spent than any type of permanent policy. However, the cost of premiums increases as the policy owner gets older and as the end of the specified term nears. Term polices can have some variations, including, but not limited to:

  • Annual Renewable and Convertible Term: This policy provides protection for one year, but allows the insured to renew the policy for successive periods thereafter, but at higher premiums without having to furnish evidence of insurability. These policies may also be converted into whole life policies without any additional underwriting.
     
  • Level Term: This policy has an initial guaranteed premium level for specified periods; the longer the guarantee, the greater the cost to the buyer (but usually still far more affordable than permanent policies). These policies may be renewed after the guarantee period, but the premiums do increase as the insured gets older.
     
  • Decreasing Term: This policy has a level premium, but the amount of the death benefit decreases with time. This is often used in conjunction with mortgage or other debt protection.

Many term life insurance policies have major features that provide additional flexibility for the insured/policyholder. A renewability feature, perhaps the most important feature associated with term policies, guarantees that the insured can renew the policy for a limited number of years (i.e., a term between five and 30 years) based on attained age. Convertibility provisions permit the policy owner to exchange a term contract for permanent coverage within a specific time frame without providing additional evidence of insurability. Of course, these provisions will raise the policy premiums accordingly.

The Bottom Line

Many insurance consumers only need to replace their income until they've reached retirement age, have accumulated a fair amount of wealth, or their dependents are old enough to take care of themselves. When evaluating life insurance policies for you and your family, you must carefully consider the purchase of temporary versus permanent coverage. There are many differences in how policies may be structured and how death benefits are determined, as well as how they are priced and their duration.

Many consumers opt to buy term insurance as a temporary risk protection and then invest the savings (the difference between the cost of term and what they would have paid for permanent coverage) in a brokerage account, mutual fund or retirement plan. In some cases, this is a good idea, but it is not necessarily always the best option, especially for those who must rely on at least a certain amount of coverage when they die.

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