Tammy teaches business courses at the post-secondary and secondary level and has a master's of business administration in finance.
In this lesson, we'll discuss the purpose and benefits of life insurance, as well as the factors that affects its cost. You'll also learn about the two main types, term life insurance and whole life insurance.
Definition of Life Insurance
Matt just graduated from college and landed his dream job at Myerson and Myerson. On his first day he is in orientation, learning about the company benefits. The facilitator tells the new hires they will discuss life insurance plans after lunch.
Matt finds the facilitator and asks, 'I'm only 25 years old and I don't need life insurance. Can I skip this session and take a longer lunch?' The facilitator smiles and hands Matt a pamphlet. He says, 'If you can answer yes to any of these questions, then you need to come back for the life insurance session.' The pamphlet defined life insurance as a product that protects from financial loss in the event of death. Then the following questions were listed:
Did your parents obtain a student loan for you in college?
Do you own a home?
Do you want to save money?
Are you married, have children or a favorite niece or nephew?
Matt realized that even at 25 years of age, he could answer 'yes' to several of these questions, and might need life insurance after all.
Benefits of Life Insurance
Many think life insurance is only for middle-aged people. But this isn't true. It is a good idea to talk to a licensed life insurance agent when you turn 18 years old, to determine if you need a policy.
For example, if your parents are helping you through college by taking out a student loan in their name, you need life insurance. If you were to die before graduating, or before the loan was paid off, your parents would still be responsible for loan payments. Life insurance proceeds could be used to pay off the loan.
In this example, you would be considered the insured, or the person being covered, and your parents would be the beneficiaries. A beneficiary is a person who is designated to receive life insurance proceeds. It's important to note a beneficiary does not need to be a family member. It can be a friend, charitable organization, a business or even a dog.
Life insurance can also be used to pay off a mortgage or other expenses, provide for college education, or simply allow the beneficiary(ies) to live comfortably.
Term Life Insurance
The simplest form of life insurance is a term policy. A term policy provides coverage for a specific period of time. Life insurance terms can be 5, 10, 15, or 30 plus years. Upon receipt of your premiums (or payments to keep the policy active), and after the agreed upon term ends, coverage ends.
Let's use the parent-student loan example again. Your parents take out a $50,000 student loan and agree to pay it off in 10 years. They can obtain a 10 year term life insurance policy, which would provide coverage if you died before the loan were paid off.
In addition to providing coverage for a specific period of time, a term policy is also the least expensive of the life insurance policies. However, the biggest disadvantage is that coverage ends at the end of the term.
Whole Life Insurance
Whole life insurance is considered permanent insurance, since it provides coverage until your death. Similar to term, whole life provides financial protection and the ability to elect your beneficiaries. However, a main advantage of whole life is that it can build cash value.
When you make monthly premiums, the life insurance company invests those premiums. If they make money from the investment, it shows on your policy as cash value. The more premium payments you make over time, and the more successful the company's investments, the more cash value your policy builds.
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The cash value in the policy can be withdrawn, borrowed against or paid out as a death proceed. For example, let's say you take out a policy for $100,000 and make 10 years of premium payments. Based on how the premium payments are invested in the market, the policy builds a cash value of $10,000.
You can withdraw the $10,000 and take out a loan to make payments back to the life insurance company (to maintain the cash value balance), or leave the cash value on the policy. If you leave the cash value intact, your beneficiaries would receive $110,000 (which is policy amount + cash value) in the event of your death.
It's important to note, whole life polices are more expensive than term policies. Also, there are many hybrids of whole life insurance, and a licensed agent can explain the advantages and disadvantages of each. Now let's discuss the life insurance application and factors that affect the premium.
Applying for Life Insurance
Life insurance coverage is a legally binding agreement between the insured and the insurance company. As long as the insured provides factual information on the application, and makes the agreed upon premiums, the insurance company will pay out the proceeds upon death.
Providing accurate information about your age, health, and occupation is essential in determining your premium. A young, healthy person's premium will be much cheaper than an older person with numerous health problems, but an older person in excellent health may pay a smaller premium than a child with cancer. Some insurance companies may require a medical examination to assess the applicant's health condition.
Risk is also a factor in considering premiums. For example, a teacher's monthly premium will be less expensive than an airline pilot's, due to the nature and risk of a pilot's job.
Life insurance, which is a product that protects from financial loss in the event of death, is an important consideration when you become an adult. Matt discovers that, even at 25 years old, there are several factors that would make him a good candidate for life insurance, such as still having student loan debt, or owning a home. There are two different types of life insurance: term and whole. Though a term policy is the least expensive, it only provides coverage for a specific period of time. Whole life insurance on the other hand, provides life-long coverage, and builds a cash value over time that can be paid out to the beneficiary, or a person who is designated to receive life insurance proceeds, upon the death of the policyholder. Many things affect the cost of a life insurance policy, including age, medical condition, and occupational risks.
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