Life Insurance Basics

In a nutshell, life insurance creates liquidity, and there are a few types of life insurance purchasers:

• Someone who wants to make sure their surviving family members can continue to live their lives with little change in the financial situation if they die earlier than expected
• Someone who wants to leave money to his or her kids, grandkids, charities, etc. if they live a normally long life
• An older individual who wants to leave money to pay for final expenses, death taxes or estate settlement costs
• A business owner who wants to use life insurance to ensure the continuation of a business or to equalize inheritance if there are children not involved in the business;

If you are getting married, buying a home, having children or grandchildren, want to fund your kids or grandkids education, are starting a business or have estate planning needs, you should seriously consider purchasing a life insurance policy.

Generally, there are two basic types of life insurance; term life and permanent life.

Term Life– Lowest Cost, Highest Coverage, Limited Time of Coverage

Think of term life as “renting” insurance.  Term is considered temporary since it only provides coverage for a period of time offered by the life insurance company and selected by you. If you die during this term, the policy pays the death benefit to the beneficiary. But if the policy is cancelled or expires prior to your death, nothing is payable. The policy term is typically between 10 and 30 years in duration and premiums are usually level and guaranteed for that period. Most insurance companies will ask you to answer detailed health and lifestyle questions and in most cases will require some type of “underwriting.”

Underwriting can include background checks regarding your health, motor vehicle history, lifestyle, etc. and can also involve the requirement of drawing blood and examining urine samples.  The good news is that today many companies are offering life insurance without the requirement for “fluids” or medical tests.  These policies are reserved for the healthiest of applicants.

Most companies also give you an opportunity to “convert” all or part of the term contract to a “permanent” contract without having to go through additional underwriting.  Term insurance does not provide any “living benefits,” like cash value or dividends, but it is less expensive than other types of insurance.  Generally, people are more receptive to buying term insurance when younger, have less income and have more financial responsibilities (i.e., income replacement, mortgage protection, college funding).

Permanent (Whole) Life– Higher Cost, Lifetime Coverage

Permanent Life is for people who want to guarantee that a death benefit will be paid, as long as premium payments are up to date.  This type of life insurance covers you for your entire life and also uses the premium payments to build cash value within the policy. Loans can be taken against the cash value, or the entire cash value can be paid to you if you surrender the policy.  Because of the guarantee of death benefits and the building of cash value, permanent life is more expensive than term life.

As we age, the need for large amounts of coverage dwindles as our objectives change. Permanent policies are much more suitable than term insurance to cover needs like final expenses, estate costs, and passing money along to the next generation. The Permanent Life family includes names like whole life (ordinary life), universal life, variable life, variable universal life, indexed life (whole life and universal life), joint life and survivorship life.  Currently Vantis Life sells the simplest version known as whole life.

The answer, as usual, is “that depends.”

If you are relatively young, have a family and lots of debt or expected debt, and want to make sure your family sees little or no financial impact in the event that you die too early, you may want to buy as much term insurance as you can afford.  And studies show that term life is more affordable that most people think.

On the other hand, if you are older and your debts are lower, and/or you want to leave money to your kids or grandkids, then whole life insurance will fit the bill.  Whole life is also good if you have relatively modest means and want to leave a little money behind for your family to pay off any final expenses or debts.  And of course business owners often use whole life to ensure the continuity of the company or to equalize inheritance for kids not involved in the business.

To help guide you, try out our life insurance calculator here.

A whole life or straight life policy requires you to pay premiums for life or up to age 121 when it matures. But you can pay the cost of your policy in a shorter period of time such as 10 or 20 years, or to a specified age such as age 65. This means your policy will be fully paid up and no more premiums are required after the end of premium-paying period and until insured’s death, policy surrender, or the contract’s maturity date.

The beneficiary is the person to whom the policy death benefit (proceeds) will be paid at the insured’s death. The beneficiary may be a person, class of persons, an institution or other entities such as a foundation, charity, corporation or a trust. Trusts may be used to manage life insurance proceeds for minor beneficiaries.

The beneficiary can also be the insured’s estate, but this is generally not recommended for the following reasons:

• Distributions to the intended beneficiaries will be delayed since the estate has to be submitted to and settled through probate court   
• The proceeds to the intended beneficiaries could be reduced through probate court
• It can expose the death benefit to taxation and fees that could otherwise be avoided

The policy owner has the right to not only name a primary beneficiary, but also secondary, tertiary, etc. (contingent). Beneficiaries can also be designated as revocable or irrevocable. At the death of the insured, the proceeds are paid to the primary beneficiary and if the primary beneficiary is not alive, to the contingent beneficiary. If no named beneficiary is living at the time of insured’s death, the proceeds will be paid to the insured’s estate. The policy owner can change the beneficiaries at any time during the insured’s life, as long as they have not been designated as irrevocable.

If your employer is paying for your life insurance coverage, it’s almost certainly a group policy that only covers you while you are employed. This means that you could be vulnerable if you lose your job or have a break in employment. Furthermore, all group coverage, provide a limited death benefit (often one to two times your salary), leaving you and your family significantly under insured.

Accelerated Death Benefit or a Living Benefit is a rider that once added to a life insurance policy, it will allow the policy owner to receive a portion of the death benefit during the insured’s life if he/she becomes terminally ill. The amount taken out will be subtracted from the policy death benefit and the balance (minus certain adjustments) will be paid to the beneficiary at insured’s death.

Most Vantis Life policies include this rider and allow the policy owner to take up to 90% of the death benefit (not to exceed $250,000) if the insured becomes terminally ill and has less than 12 months to live.

A nice feature of life insurance policies is that they provide a 31-day grace period from premium due date, during which the missed premium can be paid without any break in coverage. If you own a term insurance policy and fail to pay your premium during the grace period, your policy will be lapsed (terminated). If you own a whole life policy with sufficient cash value, the insurance company, with your authorization, can take a loan against the cash value to pay for your premium.

Once your policy is approved, issued and paid-for, the full death benefit is paid to the beneficiary regardless of when you die. You have to continue paying your premiums, however, or risk losing the policy. If the policy is lapsed due to non-payment of premium, you wouldn’t have any coverage and your beneficiary will not receive the death benefit.

Life insurance proceeds paid to named beneficiaries are generally free of federal income taxation if taken as a lump sum. An exception applies if the benefit payment results from a Transfer For Value, meaning the life insurance policy is sold or transferred for value to another party prior to the insured’s death. The life insurance policy may become taxable if you name your estate as the beneficiary, at which time the proceeds become part of your estate and may be subject to estate taxes.

Even if no one else is depending on your income, you are still likely to leave behind bills, credit card balances and final expenses such as funeral costs. These expenses could be an unnecessary burden on parents or siblings at a difficult time. You may wish to provide a bequest to your favorite charitable organization, a family member or a friend after you die. Purchasing a life insurance policy will allow you to accomplish these objectives.

You may put maximum efforts into establishing and running your business. But unless you take the right steps to protect your business, it may be significantly impaired or forced to close when you, a partner or a key employee dies. Business continuation planning is crucial to ensure the successful transfer of a company or business interests.

If you own your business in partnership with others, you will need to have a buy-sell agreement (business continuation agreement) in place, specifying what will happen to the business in the event that an owner dies. Life insurance should then be purchased (either by the business or partners) on the lives of owners equal to their percentage of ownership in the business. The death benefit can be used to fulfill the terms of the buy-sell agreement at the death of a partner.

Similarly, if you are a sole owner of a business and depend heavily on one or more of your key employees, you should purchase life insurance on their lives to protect your business in case of premature death of either of them.

When you purchase a permanent life policy (whole life is the most common type of permanent life policies), a portion of each premium you pay goes into an account called “cash value”. Cash value grows on a tax-deferred basis and will equal to the death benefit when the policy is matured or endowed. It is then paid to the policy owner. The policy can also be surrendered (redeemed) for its cash value at any time. You may also borrow from the cash value if you wish, but you will be required to pay a loan interest on an annual basis for as long as the loan is outstanding. Any outstanding loans, and accrued interest, will be deducted from the policy proceeds at the insured’s death; the balance will be paid to the beneficiary. By the same token, if you surrender your policy, you will only receive the net cash value.