Executive Summary:
Life insurance is a must for anyone with debt, investments or loved ones. It can be used to pay any debts or taxes owing at death. It can also protect family and friends in the event of an untimely death. Under certain circumstances it may also supplement retirement income (see Insured Retirement Program). There are different versions including term and permanent with guaranteed costs for specific periods of time. All death benefits are tax-free.
The Details:
It works very simply. A monthly or annual amount or ‘premium’ is paid to an insurance company. It can be paid by cheque or by monthly withdrawal from your bank account. In return the insurance company will provide a contract of insurance to the insured. If the insured should die, a pre-determined tax-free death benefit will be paid to the beneficiaries chosen by the insured.
In order to be offered a contract of insurance each insured must first go through an underwriting process. The insurability requirements are based on age and insurance amount. It could be a written application or a complete physical by a doctor. Typically, blood and urine tests, height, weight and blood pressure are the requested requirements.
There are various types of insurance to choose from. The main criteria being the period of time the company insures you. Although it has changed over the years the current most popular versions are for 10 years, 20 years or for life.
The 10 and 20-year periods are usually referred to as term insurance. Once the designated period ends, the insurance will renew at a higher premium amount. Once you reach a certain age, 75 or 80 in most cases, the insurance will expire. In other words you can lock in a specific premium for 10 or 20 years and then it will increase if you choose to continue with the insurance. Often times, if the insured is in good health, it is advisable to inquire about purchasing a new policy that might offer better rates than the existing policy is offering.
The main benefit of term insurance is that it is fairly inexpensive for the value that you ‘might’ receive. The insurance companies spread their risk across thousands of people. They know that only a very small percentage of people that buy term insurance will either hold the policy to full term or actually die, so they can afford to charge small premiums. The only limitation with term insurance is that when you need it most, it won’t be there, because most term insurance expires at age 75 or 80, which is most likely just before you will.
An alternative or complement to term insurance is known as permanent insurance. Permanent insurance guarantees a fixed premium amount for life. If you buy permanent insurance at age 35 you will always pay the rates of a 35 year old, regardless of how old you are or any negative changes in your health status. The insurance company is well aware however that one day you are going to go. If you own a permanent policy they will some day have to pay out a benefit. As a result they will have to charge you higher premiums than they would for the equivalent amount of term insurance.
Permanent insurance comes in two main forms, universal life and whole life. Both will base future cash values and death benefits, beyond certain minimums, on projected growth rates that are not guaranteed. With a universal life policy the insured makes the decision as to where excess funds are invested. These choices can range from guaranteed investment certificates to stock market indices or even mutual funds. Some people call it a self-directed insurance policy. With a whole life policy the returns are based on the performance of the participating fund. This is a fund managed by the insurance company and the return on this fund helps determine the amount of dividends that will be provided to whole life policyholders each year.