What You Should Know About Buying Life Insurance

2/15/2015

Life Insurance: The Foundation of Financial Security

Buying life insurance is not like any other purchase you will make. When you pay your premiums, you're buying the future financial security for your family that only life insurance can provide. Among its many uses, life insurance helps ensure that, when you die, your dependents will have the financial resources needed to protect their home and the income needed to run a household.

Choosing a life insurance product is an important decision, but it often can be complicated. As with any major purchase, it is important that you understand your needs and the options available to you.

That's where this booklet comes in; read it thoroughly. It takes you through the basics, step-by- step, as you prepare for this significant purchase. Most important, it will help you know what questions to ask when you're buying life insurance.

Life insurance also can be used to help with other financial goals, such as funding retirement or education expenses. However, it is important to remember that the main purpose of life insurance is financial protection. If your primary goals are something other than protection, you should consider what other financial products are available to meet those goals.

The information in this brochure has been compiled by the American Council of Life Insurance, a trade association of more than 600 life insurance companies. Collectively, these companies provide about 90 percent of the life insurance in force in the United States.

Learning the Basics

The best way to make an informed decision about buying life insurance is to become familiar with the basics.

Why Do I Need Life Insurance?

Life insurance is an essential part of financial planning. One reason most people buy life insurance is to replace income that would be lost with the death of a wage earner. The cash provided by life insurance also can help ensure that your dependents are not burdened with significant debt when you die. Life insurance proceeds could mean your dependents won't have to sell assets to pay outstanding bills or taxes. An important feature of life insurance is that no income tax is payable on proceeds paid to beneficiaries.

How Much Life Insurance Do I Need?

Before buying life insurance, you should assemble personal financial information and review your family's needs. There are a number of factors to consider when determining how much protection you should have.

These include:

Although there is no substitute for a careful evaluation of the amount of coverage needed to meet your needs, one rule of thumb is to buy life insurance that is equal to five to seven times your annual gross income.

What is Term Insurance?

Term insurance provides protection for a specific period of time. It pays a benefit only if you die during the term. Some term insurance policies can be renewed when you reach the end of a specific period which can be from one to 20 years. The premium rates increase at each renewal date. Many policies require that evidence of insurability be furnished at renewal for you to qualify for the lowest available rates.

What is Permanent Insurance?

Permanent insurance provides lifelong protection and is known by a variety of names, described later. As long as you pay the necessary premiums, the death benefit always will be there. These policies are designed and priced for you to keep over a long period of time. If you don't intend to keep the policy for the long term, it could be the wrong type of insurance for you.

Most permanent policies including whole, ordinary, universal, adjustable and variable life have a feature known as "cash value" or "cash surrender value". This feature, which is not found in most term insurance policies, provides you with some options:

You can cancel or "surrender" the policy "in total or in part" and receive the cash value as a lump sum of money. If you surrender your policy in the early years, there may be little or no cash value.

If you need to stop paying premiums, you can use the cash value to continue your current insurance protection for a specific period of time or to provide a lesser amount of protection to cover you for as long as you live. Usually, you may borrow from the insurance company, using the cash value in your life insurance as collateral. Unlike loans from most financial institutions, the loan is not dependent on credit checks or other restrictions. You ultimately must repay any loan with interest or your beneficiaries will receive a reduced death benefit.

The cash values of many life insurance policies may be affected by your company's future experience, including mortality rates, expenses and investment earnings. Keep in mind that with all types of permanent policies, the cash value of a policy is different from the policy face amount. Cash value is the amount available when you surrender a policy before its maturity or your death. The face amount is the money that will be paid at death or at policy maturity.

What are the Types of Permanent Insurance?

There are many different types of permanent insurance. The major ones are described below:

Whole Life or Ordinary Life

This is the most common type of permanent insurance. The premiums for a whole life policy must be paid periodically in the amount indicated in the policy. These premium amounts generally remain constant over the life of the policy.

Universal Life or Adjustable Life

This variation of permanent insurance allows you, after your initial payment, to pay premiums at any time, in virtually any amount, subject to certain minimums and maximums. You also can reduce or increase the amount of the death benefit more easily than under a traditional whole life policy. (To increase your death benefit, you usually will be required to furnish the insurance company with satisfactory evidence of your continued good health.)

Variable Life

This type of permanent policy provides death benefits and cash values that vary with the performance of an underlying portfolio of investments. You can choose to allocate your premiums among a variety of investments which offer varying degrees of risk and reward stocks, bonds, combinations of both, or accounts that provide for guarantees of interest and principal. You will receive a prospectus in conjunction with the sale of a variable product.

The cash value of a variable life policy is not guaranteed, and the policyholder bears that risk. However, by choosing among the available fund options, the policyholder can create an asset allocation that meets his or her objectives and risk tolerance. Good investment performance will lead to higher cash values and death benefits. On the other hand, poor investment performance will lead to reduced cash values and death benefits.

Some policies guarantee that death benefits cannot fall below a minimum level. There are both universal life and whole life versions of variable life.

What are the Advantages and Disadvantages of Term and Permanent Insurance?

Term Insurance

Advantages

Disadvantages

Permanent Insurance

Advantages

Disadvantages

Getting Started

After you have thought about your financial needs and have become familiar with the basic types of life insurance, you will need to choose a company and agent.

The Agent Visit

Now that you have reviewed the basics of life insurance and thought about your personal financial needs, you can shop for a life insurance policy with more confidence and knowledge.

What can I expect during an agent visit? The agent you have selected will meet with you to discuss your life insurance needs. He or she will ask questions about family income and your net worth. Using the information you already have assembled about your financial situation, you should be prepared to discuss your insurance options.

Will the agent ask questions about my health? In this initial meeting, be prepared to answer questions about your health (for example, age, medical condition, medical history, family history, personal habits). It is important that you answer these questions carefully and truthfully; this information helps a company charge a fair premium for your coverage. For instance, you may pay a lower premium if you don't smoke. On the other hand, if you have a chronic illness, you may be charged a higher premium.

Also, in the event of a claim, accurate and truthful answers enable your beneficiary to receive prompt payment. Inaccurate or untruthful answers, however, may cause delay or even denial of a claim.

When you apply for life insurance, you may be asked to have a medical exam. Often, a licensed medical professional will make a personal visit.

Your Agent's Recommendation

Once you have discussed your financial needs and objectives with your agent, he or she will recommend the type of life insurance policy that will best suit your purposes. Often, the agent will provide a "policy illustration" that will show how your policy will work.

Carefully study your agent's recommendation and ask for a point-by-point explanation if there are items you don't understand. Because your policy is a legal document, it's important that you know what it provides.

Here are some other questions you should ask:

If your agent recommends a permanent policy, consider the following:

Ask your agent for an explanation of the illustration; some figures are guaranteed and some are not. Remember that the insurance company will honor the guaranteed figures regardless of its future financial experience.

If your policy is a variable life policy, be sure that the interest rate assumed is reasonable for the underlying investment accounts to which you choose to allocate your premiums. For example, some investment advisors suggest that a higher interest rate assumption may be warranted if you plan to allocate your premium to a stock account, while a lower rate should be assumed for more conservative alternatives.

It is important to keep in mind that an illustration is not a legal document. Legal obligations are spelled out in the policy itself.

Here are additional questions to ask about the policy illustration:

Final Tips

Here are a few tips to keep in mind about your life insurance purchase:Take your time. On the other hand, don't put off an important decision that would protect your family. Make sure you fully understand any policy you are considering and that you are comfortable with the company, agent and product. Don't rush into a decision just because you are feeling pressured.When you purchase a policy, make your check payable to the insurance company, not to the agent. Be sure you are given a receipt.

After you have purchased an insurance policy, keep in mind that you may have a "free-look" period usually 10 days after you receive the policy during which you can change your mind. During that period, read your policy carefully. If you decide not to keep the policy, the company will cancel the policy and give you an appropriate refund. Ask your agent.

Review the copy of your application contained in your policy. Promptly notify your agent or company of any errors or missing information.If an agent or company contacts you and wants you to cancel your current policy to buy a new one, contact your original agent or company before making any decisions. Surrendering your policy to buy another could be very costly to you.

If you have a complaint about your insurance agent or company, contact the customer service division of your insurance company.

If you still are dissatisfied, contact your state insurance department. Most departments have a consumer affairs division that can offer help.Review your policy periodically or when your situation changes to be sure your coverage is adequate.

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