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What You Should Know About Buying Life Insurance

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 document 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 document 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: any immediate needs at the time of death, such as final illness expenses, burial costs and estate taxes; funds for a readjustment period, to finance a move or to provide time for family members to find a job; and ongoing financial needs, such as monthly bills and expenses, day-care costs, college tuition or retirement. 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.l 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

Initially, premiums are generally lower than those for permanent insurance, allowing you to buy higher levels of coverage at a younger age when the need for protection often is greatest.l It's good for covering specific needs that will disappear in time, such as mortgages or car loans.

Disadvantages

Premiums increase as you grow older.l Coverage may terminate at the end of the term or may become too expensive to continue.l Generally, the policy doesn't offer cash value or paid-up insurance.

Permanent Insurance

Advantages

As long as the necessary premiums are paid, protection is guaranteed for your entire life.l Premium costs can be fixed or flexible to meet personal financial needs.l Policy accumulates a cash value that you can borrow against. (Loans must be paid back with interest or your beneficiaries will receive a reduced death benefit.) You can borrow against the policy's cash value to pay premiums or use the cash value to provide paid-up insurance. The policy's cash value can be surrendered' in total or in part ' for cash or converted into an annuity. (An annuity is an insurance product that provides an income for a person's life-time or for a specific period of time.)l A provision or “rider” can be added to a policy that gives you the option to purchase additional insurance without taking a medical exam or having to furnish evidence of insurability.

Disadvantages

Required premium levels may make it hard to buy enough protection.l It may be more costly than term insurance if you don't keep it long enough.

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