Life Insurance 101

What Is Life Insurance?

Life insurance is a financial safety net for the people you care about. You pay premiums to an insurance company, and if you pass away while the coverage is in force, the company pays a death benefit to the beneficiaries you have chosen.

For most families, life insurance is about answering one important question: “If something happens to me, will the people I love have the financial resources they need to move forward?”

Families use life insurance for many reasons. The death benefit can help replace lost income, continue mortgage or rent payments, pay household bills and debts, provide for children’s education, cover final expenses, and give loved ones time to adjust financially without immediately having to make difficult decisions because money is running short.

Life insurance can also be used for longer-term purposes. Parents and grandparents may use permanent life insurance as part of planning for children and grandchildren. Others use it to leave a legacy to family, a church, charity, or other organization that is important to them.

For business owners, life insurance can also help protect a business, provide funds following the death of an owner or key employee, or support certain business-succession strategies.

Ultimately, life insurance is not simply about preparing for death. It is about protecting the financial lives of the people who continue living.

Term Life Insurance

Term insurance is often the simplest and initially most affordable form of life insurance.

You purchase a specified amount of coverage for a defined period, commonly 10, 20 or 30 years.

If the insured dies while the policy is in force, the beneficiary receives the policy’s death benefit, subject to the policy terms. Traditional term insurance generally does not accumulate cash value.

When Might Term Life Insurance Make Sense?

Term life insurance may be a good choice when you need a larger amount of life insurance protection for a specific period of time at an affordable cost.

For example, you may want coverage while you are raising children, paying a mortgage, supporting a spouse or partner, or during the years when your family depends most heavily on your income.

Term life insurance (the death benefit) can help provide money to:

• Replace income your family would lose if you died.
• Help pay the mortgage or rent and other household expenses.
• Pay debts and other financial obligations.
• Help fund children’s education.
• Provide additional protection during your primary working years.
• Protect certain temporary business obligations.

Think of term insurance as protection for a period when your financial responsibilities may be at their greatest.

For example, parents with young children and a mortgage may need substantial life insurance today, but their needs could be very different 20 or 30 years from now after the children are grown, the mortgage is paid down, and additional assets have been accumulated.

Because term insurance generally does not build cash value, it is primarily designed to provide a death benefit during the selected coverage period. If you need protection that is intended to last for your entire lifetime or you want the potential to accumulate cash value, permanent life insurance may be another option to consider.

What happens when the term ends?

That depends upon the policy. Coverage may terminate, the policy may allow renewal at a substantially higher premium, or it may contain a conversion privilege allowing some or all of the term insurance to be converted to permanent insurance within specified time limits.

That is why it is important to consider not only today’s premium, but also how long you expect to need the coverage.

Whole Life Insurance

Whole life is a form of permanent life insurance. Unlike term insurance, which is designed to cover a specified period, whole life is generally designed to provide lifetime protection as long as required premiums are paid and policy requirements are satisfied.

Whole life policies typically include both: A death benefit for beneficiaries, and Cash value that accumulates within the policy. Depending on the contract, whole life insurance may offer guaranteed premiums, guaranteed cash values and a guaranteed death benefit, provided the policy requirements are met.

What can whole life insurance be used for?

Whole life may be appropriate for needs that are unlikely to disappear simply because someone reaches a particular age.

These can include:

• Final expenses and burial costs.
• Lifetime family protection.
• Legacy planning.
• Providing money to children or grandchildren.
• Certain estate-planning needs.
• Business-planning needs.
• Building accessible cash value over time.

The policyowner may be able to access available cash value through withdrawals or policy loans.

However, cash value is not a separate account sitting outside the policy. Loans and withdrawals can reduce cash value and the death benefit and may have tax consequences or cause a policy to lapse if not properly managed.

Indexed Whole Life Insurance

Indexed whole life combines features of permanent whole life insurance with an interest-crediting approach that may be linked, in part, to the performance of an external market index.

The policyowner generally is not investing directly in the stock market or buying shares of the index. Instead, the insurance company uses a formula described in the policy to determine how interest may be credited. Depending upon the product, that formula may incorporate features such as caps, participation rates, spreads or floors.

Indexed whole life is intended to provide permanent life insurance while offering cash-value accumulation potential under the policy’s crediting methodology with guarantees.

Because designs vary substantially among insurance companies, consumers should review the actual policy illustration, guarantees, crediting methodology, costs and limitations rather than selecting a policy based only upon the word “indexed.”

Indexed Universal Life Insurance (IUL)

Indexed Universal Life, or IUL, is permanent life insurance designed to provide a death benefit while also offering the potential to accumulate cash value.

The policy is not directly invested in the stock market. Instead, interest credited to the policy may be linked to the performance of an external market index.

When the applicable index has a positive period, the policy may receive positive interest crediting according to the policy’s terms. When the index has a negative period, an indexed strategy with a 0% floor generally receives 0% index interest rather than the negative market return.

Over time, positive interest credits can become part of the policy value and contribute to the power of compounding.

An IUL can therefore combine three important concepts:

Life insurance protection + cash-value accumulation potential + protection from direct negative index returns.

IUL policies can be designed for objectives including family protection, legacy planning, supplemental retirement-income strategies and long-term financial planning. It should be designed and reviewed with a long-term objective in mind.

Why do people consider IUL?

When appropriately designed and funded, an IUL may be considered for objectives such as:

• Permanent life insurance protection.
• Cash-value accumulation.
• Supplemental retirement-income strategies.
• Legacy planning.
• Family financial protection.
• Children’s long-term financial planning.
• Certain business-planning strategies.

Some policies allow flexibility in premiums and death benefits, subject to policy requirements and applicable limits.

That flexibility also means an IUL requires appropriate design and ongoing monitoring.

Insurance charges, credited interest, premium funding, loans, withdrawals and other policy activity can affect future cash value and the ability of the policy to remain in force.

An IUL should therefore be evaluated as a long-term life insurance contract, not simply on the basis of an illustrated future cash value.

What Is Mortgage Protection?

Mortgage protection is not necessarily a completely separate category of life insurance. It describes a purpose for which life insurance is purchased.

A life insurance policy can be structured so that, if the insured dies, the beneficiary has funds that may help continue mortgage payments or pay off some or all of the remaining mortgage.

Importantly, when an individually owned life insurance policy is used for mortgage protection, the death benefit is generally paid to the named beneficiary, not automatically to the mortgage company, unless the policy or an assignment provides otherwise. The beneficiary can then use the proceeds according to the family’s needs.

What Is Final Expense Insurance?

Final expense insurance is generally permanent life insurance with a smaller death benefit intended primarily to help address expenses associated with death.

Those expenses might include:

• Funeral services.
• Burial or cremation.
• Cemetery expenses.
• Outstanding medical or household bills.
• Other expenses left to surviving family members.

Final expense policies may have simplified underwriting, although eligibility, health questions, benefit amounts and waiting periods vary considerably by insurer and product. Some policies may offer first-day coverage to qualifying applicants, while others may contain graded or modified benefits.

What Does “Guaranteed Issue” Mean?

A policy offering first-day full coverage generally provides the full death benefit from the policy’s effective date for covered causes of death, subject to the policy’s terms and exclusions.

However, Guaranteed-issue life insurance generally means an applicant can obtain coverage without traditional medical underwriting, subject to the insurer’s eligibility requirements such as age and jurisdiction. That does not mean every feature is guaranteed or that every guaranteed-issue policy provides the full death benefit immediately for every cause of death.

The words “Guaranteed Issue” generally refer to how someone qualifies for the policy, not necessarily when the full death benefit becomes available.

Consumers should therefore ask: “Is this first-day full coverage, or does the policy have a waiting or graded-benefit period?” That distinction can be extremely important.

What Is a Waiting Period?

A waiting period means the policy is issued and coverage begins, but the full death benefit for death from natural causes may not be available during an initial period, commonly the first two years.

If the insured dies from natural causes during that waiting period, the beneficiary may receive a refund of the premiums paid, sometimes with additional interest, rather than the full face amount of the policy. The exact benefit depends on the policy.

After the waiting period has been satisfied, the full death benefit becomes available for covered causes of death, subject to the policy’s terms.

Accidental death may be treated differently and may provide the full death benefit from the beginning, depending on the policy.

What Is a Graded-Benefit Period?

A graded-benefit period also limits the amount payable for certain deaths during the policy’s early years, but instead of simply waiting until a particular date for the full benefit, the death benefit may increase in stages.

For example, a policy might provide a smaller percentage of the death benefit during the first year, a larger percentage during the second year, and the full death benefit beginning in a later year. Other policies use different graded-benefit formulas.

The important point is that the full face amount may not be payable immediately for death from natural causes.

Always review the actual policy provisions. Waiting periods, graded benefits, accidental-death provisions, premium refunds and eligibility requirements vary by insurance company and policy.

Can Life Insurance Cover Children and Young Adults?

Yes. Parents and grandparents sometimes purchase permanent life insurance for children or young adults. The purpose may extend beyond providing a death benefit.

Depending upon the policy, purchasing coverage while a child is young may:

• Establish life insurance protection at an early age.
• Begin accumulating cash value over a longer period.
• Provide future financial flexibility.
• Support long-term legacy planning.
• Help protect future insurability, depending upon policy provisions.

Some permanent policies also offer options to purchase additional insurance later without undergoing the same type of medical underwriting, subject to the policy’s terms.

Can Life Insurance Help With College or a Child’s Future?

Certain cash-value life insurance policies may be designed as one component of a broader long-term financial strategy for a child. Over time, accumulated cash value may potentially be accessed for needs such as education, starting a business, purchasing a home or other future financial objectives.

However, life insurance should not be represented as a college savings account or guaranteed investment. The primary purpose of life insurance remains the death benefit, and accessing cash value through loans or withdrawals can reduce policy values and death benefits and may create other consequences. Families should compare life insurance with other education and savings alternatives based upon their objectives.

How Much Life Insurance Do You Need?

There is no universal number. A meaningful life insurance review should consider your financial responsibilities and the people who depend upon you.

Questions may include:

• Income: How much of your income would your family need to replace?
• Mortgage and debts: What obligations would remain?
• Children: How many years of financial support may still be needed?
• Education: Do you want to provide funds for college or other education?
• Final expenses: What costs could your family face at death?
• Existing assets: What savings, retirement assets and existing insurance are already available?
• Legacy: Do you want to leave money to children, grandchildren, a church, charity or another organization?
• Retirement: Are there long-term financial objectives that permanent insurance might complement?

The answer is often more useful when expressed as a financial need rather than an arbitrary multiple of annual income.

Life Insurance Is Not One-Size-Fits-All

A healthy young family, a business owner, a retiree, a grandparent purchasing coverage for a grandchild and someone primarily concerned about burial expenses may all need life insurance, but they may need very different policies.

The objective should not be to purchase the policy with the most features.

It should be to identify:

• What are you protecting?
• How long does the protection need to last?
• How much can you comfortably afford?
• Do you need cash-value accumulation?
• What guarantees are important to you?
• How much flexibility do you need?

Once those questions are answered, different types of coverage can be compared more intelligently.

Start With Education, Then Look at Your Options

At Be Smart With Your Money®, we believe life insurance should be understood before it is purchased. Our role is to help you identify your objectives, understand the differences among available types of coverage, and evaluate solutions from the insurance carriers available to us for which you may qualify. A consultation does not obligate you to purchase coverage.