How It Works
You buy a policy and pay the monthly or annual fees (a.k.a: premiums) on time. If you die the insurance company pays your family, or whoever you named as the beneficiaries, the amount of money specified in the policy. Like the lottery, there’s a choice to receive the money all at once (lump sum) or in installments (annuity). Unlike the lottery, this is an investment that actually pays off.
Types of Life Insurance
There are two main types of life insurance: term and permanent (or whole life).
Term Insurance covers you for a set amount of time. If you have a 20-year plan, and you keep up payment and cease to be living within those 20 years, YAHTZEE! Your beneficiaries get the money. If you’re still around after those 20-years the plan expires then you have to get a new policy if you can still qualify.
The Upside: You’re still alive!
The Downside: All that money you spent was for nothing. [Dig Deeper: Term Life Insurance]
Permanent Insurance (a.k.a. Universal or Whole Life) never expires. You either pay it all at once, which is very expensive, or in installments, which is also very expensive, but it lasts forever.
These policies have an investment element, meaning that some of the money can be invested in the stock market or taken out as a cash loan, so you still have the option to access the money while you’re still alive. [Dig Deeper: Permanent Life Insurance]
Where Can You Buy It?
If you’re a full-time employee interested in purchasing insurance, check with your boss to see if the company offers Life Insurance as a benefit. Also, if you happen to have ever glanced at a TV, you’re well aware that insurance companies aren’t exactly laying low. They advertise non-stop. Feel free to hit one up and find out what they charge.
Who Should Have It?
- If you have kids, you should have it.
- If you support your spouse, you should have it.
- If you’re the type of person who is concerned about being dumped in a terrible nursing home because you can’t afford a good one, look into Long-Term Care Insurance.
Everyone else can just go on about their business.
How Much Do You Need?
Be realistic and ask yourself: How much money will your family need in order to live comfortably after you're gone?
You know how people always complain that athletes make too much money? Well, some do. But most have a limited window to make as much as they can so it lasts the rest of their lives. The smart ones with legit financial planners have breathing room to live comfortably and support their family while they transition into a new career after retirement.
If your family has no money coming in, how long could they continue to live in the style they are used to? If you are have ongoing expenses, such as college tuition or a mortgage, how long could your family make those payments?
Take a moment when you’re paying the monthly bills, or when you’re doing your taxes, and get a general idea of how much you spend. House payments, car payments, utilities, etc… By considering how much money your family will need to live, you can determine how much life insurance you should buy.
You Can’t Go It Alone: Get An Insurance Agent
The concept of Life Insurance isn't necessarily complex, but the reality can be incredibly complicated, which is why you need a licensed agent. Their job is to help you understand how much insurance you need in terms you can easily understand.
What Life Insurance Agents Do
When they’re not solving crimes or working on their rock-hard washboard abs, a Life Insurance agent's only goal in life is to help you find a policy that best meets your needs in terms of your family obligations, finances, health, and personal circumstances.
You should be presented with a number of options that meet your criteria, and the agent should clearly explain the details, advantages, and drawbacks of each option. If you have questions, they should provide understandable answers. You should never feel pressured into making a purchase. Once you’ve purchased a policy, the agent should be available to review the details of the policy, including beneficiary designations, every few years.
Judge Your Agent in Three Steps
1. Is the agent properly licensed? They must have a current up-to-date license issued by the state in which they sell insurance. Just ask them. If you’re still unsure, which is a red flag in itself, check with your state's insurance department. If your agent claims to have a “license to kill” that means he’s James Bond. Hire him immediately!
2. Are they experienced? Not in worldly affairs, but in working with people in your situation. In some cases, the agent may be able to provide you with client references.
3. Does the agent have lots of official looking initials after their name? Many insurance agents complete additional training and courses to obtain advance credentials. Some popular credentials include
- Chartered Life Underwriter (CLU)
- Chartered Financial Consultant (ChFC)
- Certified Financial Planner (CFP)
- Financial Services Specialist (FSS)
These advance credentials often signal a commitment to the profession and ethical business practices. Or they just added them after their name as a practical joke.* **
*Note For People Who Want To Buy Insurance: Insurance Agents aren’t really known for their sense of humor.
**Note For Insurance Agents: We’re just kidding. You’re hilarious!
Who Gets The Payout? Beneficiaries Do.
The beneficiaries you name in your Life Insurance policy are the people who will receive the money from the policy if something happens to you. Who could these people be?
Oh, would you look at that. We compiled a list of possible beneficiaries in your life. How handy and helpful of us:
- A person or a group of people, such as a family member or multiple family members
- A Trust you’ve established
- A charity or nonprofit organization
- Your estate
Warning: Some states have restrictions on who can be named as a beneficiary. This is where your charming local insurance agent can clear up any questions.
If Your Beneficiaries Die Before You...
Enter the contingent beneficiaries (aka: secondary beneficiary). This is the person who gets the money if your primary beneficiary isn’t alive if/when you die. If the primary beneficiary is alive at the time you die, the contingent beneficiary gets nothing. However, if the primary beneficiary has died, the contingent beneficiary will receive the benefits of the policy. If this were an episode of Columbo, then it’s quite obvious the contingent murdered the primary to get the loot. But since this is real life, that doesn’t happen.
<Everplans starts to leave the room before nonchalantly turning back around>
Just one more thing...
Always Review Beneficiary Designations
It’s a good idea to review who you've chosen as beneficiaries every few years, as well as after major life events in case you want to make changes (births, deaths, marriage, divorce, etc...).
Creating A Trust To Pay For Insurance and Avoid Taxes
Take our hand as we guide you through the magical world of ILIT.
An Irrevocable Life Insurance Trust (ILIT) is used to avoid estate taxes on insurance payouts. By establishing one of these and paying policy benefits directly into it, beneficiaries don’t have to pay income or estate taxes.
Yep, insurance policy cash is subject to estate tax. To avoid it you must create a Trust. Do you want to know how that works?
Of course you do. Fear not, we’re here to keep things simple. And simple we shall be!
Step 1: Establish an Irrevocable Trust. Hmm, seems easy enough. A Trust is like having a thriving business that doesn’t make you money. Sorta like the Internet. You do paperwork with an attorney, open a bank account in the Trust’s name, transfer money into that account from one of your savings or checking accounts, and only use that account to pay your Life Insurance premiums each year.
Step 2: A Trust requires someone to look after it, which is called the Trustee(s). This is most likely your spouse or children, who also serve as beneficiaries of the Trust.
Step 3: The insurance policy is transferred to the Trustee so you no longer own the policy. This means that any future payouts can’t be counted among your assets. You can no longer claim to have a $5 million policy because it’s not yours anymore. The Trust has it now.
Step 4: This is where things start heating up. The ILIT is named as the beneficiary of your Life Insurance policy. BOOM! Not your spouse or kids. That bank account you set up receives the entire payout. This way the beneficiaries of the Trust--spouse and/or kids--can receive the benefits of the policy without having to pay income or estate taxes.
Postscript: This isn’t as easy as it sounds...mainly because it’s not really easy at all. There are lots of moving parts and small details to deal with (example: bank fees can be a real nuisance). If you mess any of it up this could all be a massive waste of time and money.
However, if you have one of these in place and something happens to you it’s a huge benefit for your family. This is where contacting a trust and estate attorney to help you make these arrangements is quite beneficial. But at least now you know how it works.
Insurance policies offer a basic level of coverage with basic conditions, restrictions, and requirements. Like a car you buy directly off the lot.
Insurance riders are additional provisions, usually at a cost, that customize a standard policy. This is like adding power windows, satellite radio, and heated seats to the car. It’s not necessary but it makes it a lot more comfy. Let’s get into the various types.
Accelerated Death Benefit
This provides financial assistance if you become diagnosed with a terminal illness.
How It Works: If you become terminally ill, you can take out a portion of the death benefit from your insurance policy as cash, which can then be used to cover the costs of medical expenses, treatments, or long-term care. You’re borrowing against your policy and any cash that’s taken out of the policy is subtracted from what your beneficiaries get when you die.
Reasons For Buying: It’s a good idea if you have a family history of illness. If you’re already sick you usually can’t buy it anymore.
Accidental Death Benefit (Double Indemnity)
If you’ve seen the classic movie you know what this is. For those that haven’t, your beneficiaries receive an additional payout, often double the amount they’d normally receive, if your death occurs as the result of an accident.
Reasons For Buying: If you work in a potentially dangerous environment (heavy machinery, remote location, etc...) or drive more than average (either professionally or as a commuter), an accidental death benefit rider might be a good idea.
Reasons It May Be Voided: If the death results from service in the armed forces or injuries sustained in war, illegal activities, self-inflicted injuries, or “hazardous hobbies” (such as skydiving, deep sea diving, motorsports, mountaineering...). Remember, it’s “accidental death benefit” not “staring death in the face on a weekly basis and hoping you walk away in one piece benefit.”
Family Income Benefit Rider
This is if you’d like benefits to be paid out in installments over time on a monthly basis, for a set number of months.
How It Works: Benefits are usually paid out to beneficiaries in a one-time lump sum, though you may have the option of distributing benefits in installments. If that’s what you want, then this is the rider for you.
Reasons For Buying: This rider mimics a steady income for beneficiaries. If there are concerns about the beneficiaries’ ability to successfully manage money, this can help achieve those goals indirectly.
Long-Term Care Rider
This adds coverage for potential long-term care needs that otherwise wouldn’t be part of the the initial policy. This is for people who want long-term care coverage but don’t want to buy a separate dedicated long-term care (LTC) policy.
How It Works: This kicks in and helps out if you can no longer take care of yourself due to disabling medical, physical, or cognitive conditions. Unlike health care, this focuses on basic activities of daily living, such as getting dressed, getting in and out of bed, using the bathroom, eating, and so forth. An LTC rider can cover many different forms of care, including in-home care, nursing home care, adult day care, and long-term care facilities, among others.
Reasons For Buying: We hate to bring up stats, but we just can’t resist. Statistically speaking, at least 70% of people above the age of 65 will require some amount of long-term care. This means most seniors should be prepared to enter and pay for long-term care at some point. Without insurance, the costs of long-term care can be overwhelmingly expensive, and can quickly deplete savings. For example, in 2011 the average monthly cost for assisted living was $3,477, which translates to over $40,000 per year.
Difference between the rider and stand-alone LTC plan: The cost of a long-term care rider is significantly less than the cost of a dedicated long-term care insurance policy, while providing many of the same benefits to the insured. If you are worried about needing long-term care at some point, purchasing a long-term care rider can help lessen any anxiety you may be feeling about how to pay for that care.
Still A Bit Costly: The addition of a long-term care rider often results in a significantly higher premium. That said, the cost of a long-term care rider is usually much less than the cost of a separate long-term care insurance policy.
Sell Your Insurance Policy
If you bought a Life Insurance policy to protect your family, but now your children are adults or your spouse is no longer around, you might not want to stop paying the premiums just yet. It may be worth something to the correct group of people. (No, not the mob. Let's keep this safe and legal, people.) Namely, businesses that buy insurance policies, which is called Life Settlements. Do a search and find out more if this is applicable to your situation.