Fundamentals of Life Insurance

Review the fundamentals of life insurance to plan, prepare, provide for loved ones. Don’t wait, ensure your family will be well cared for! Part of providing for your family is to make sure they are financially prepared for life in the event of your untimely passing. While this may not be a particularly easy topic to think about, and perhaps not pleasant, it is a critical tool and fundamental component of a well-built financial plan for your family.

What is Life Insurance?

A core theme of this blog is the concept of Mêtis and applying it in the day-to-day. Life Insurance fits within the scope! It is a great way to protect your family and loved ones against the unfortunate event of an untimely death. This post focuses on the essential concepts of life insurance coverage outside of what is broadly available from your employer. My friend, I applaud you for doing the research: understanding the basics of life insurance and how it applies to your profile is part of building financial literacy.

At a basic level, Life Insurance contracts are legal documents that consist of a variety of terms and features. These options are designed to meet the unique array of needs a policyholder may be faced with. A life insurance policy provides a death benefit to the beneficiaries in exchange for premiums paid to the insurance company. Depending on the terms and types of the policy, the premiums are paid at various intervals over the course of time.

Broad Categories of Life Insurance

Life Insurance comes in many forms and variations. Some of the major categorizations of available options are Term and Whole Life insurance policies. Under each of those, there are myriad flavors and specifications. (Always make time to read and understand the contract before you sign!)

Fundamentals of Term Life Insurance

Generally speaking, Term policies are fixed for a set length of time (e.g. 10 years). Term policies provide a specific death benefit from the insurance company to the beneficiaries upon the death of the insured. (Provided the death of the insured occurs within the term of the contract). Term policies are generally the cheapest option.

Term policies can be further identified as either level or decreasing terms. Most are level, which means the death benefit is constant. (Decreasing means the death benefit decreases at a set point over the term).

In both cases, keep in mind that the policy will not last forever. At the end of the term, they are of no value. If you decide to stop paying the premium, or if the policy is surrendered, the contract will be terminated.

Fundamentals of Whole Life Insurance (also called Permanent Insurance)

To differentiate, Whole Life policies are for the whole life of the insured. Subdivisions of this category include Traditional Whole Life, Universal Life, and Variable Universal policies.

Unique aspects of these policies include the “cash” part, (also referred to as the investment portion) and then the insurance. Whole Life is more consistent in terms of structure, and Universal tends to offer more custom options.

The ability to toggle and customize facets of the contract is an attractive benefit for some. That benefit comes with a higher cost and you should approach Whole Life policies with caution. Make sure you actually need these types of benefits before purchasing them. With all the flexibility and robust nature of the policy, there are also a lot of rules to keep in mind. I recommend consulting with a trusted firm or individual that specializes in estate management and insurance. They will help you determine fit and will guide you to achieve the desired results.

Life Insurance Terms to Know

Understanding the fundamentals of life insurance means understanding the terms! Here, I’ve captured some of the basics so you can reference them when reading through an insurance policy. This is not exhaustive but should serve well as a starting point.

• Beneficiary: When the insured dies, these are the people (entity, or person) receiving the life insurance payout (benefit).
• Cash Value: When you pay premiums, this collects and the balance grows tax deferred. This is part of a permanent life insurance policy.
• Death Benefit: If the insured dies and assuming the policy is active, this is the amount paid to the beneficiary (-ies).
• Insured: If you buy life insurance policy for yourself, you are the insured. This insured is the one insured by the policy.
• Owner: This is the person buying the policy.
• Premium: This is the payment you must make in order for the policy you just purchased to stay inforce. (Note, this could be all at once (ie lump sum) or a schedule of payments, like monthly).
• Rider: Think of these as “add-ons” to customize your policy, for specifics not otherwise covered under standard coverage.
• Underwriting: When you buy a policy, the insurance companies evaluate the risk profile of the insured.

Discussing Life Insurance Fundamentals

Firstly, it is important to note that while insurance needs and policy types vary for the individual, my opinion is that there should always be an insurance policy in place for every household. Part of being a good father and husband means providing for the family. This of course holds true and applies while I’m alive. And, if I am called home early, I believe it applies then, to a certain extent, as well.

In my opinion, and for my current situation, Term policies are generally the most affordable, allow for a straightforward and most desirable overall approach to achieving coverage. Over the course of the stated term of the policy, the goal is to become self-insured at the end. I have heard Dave Ramsey say the best approach is to buy term and invest the difference. I tend to agree with him there! Buying a term policy, paying the premium, and then investing in a Roth IRA is a powerful combination.

How much Life Insurance is Needed?

Personally, I have coverage through my work and through an individual policy as well. However, keep in mind that individual needs will vary depending on those unique circumstances. I bought as much as we could afford with the budget that my wife and I have in place at this time.

Is see the question answered in two ways. Firstly, how much can you afford? Part of answering that question is to ensure you have a proper budget in place. Use the budget to get a better idea of how much you can afford to spend on premiums. Secondly, I recommend using the 5 W’s. Who, What, When, Where, and Why… Here are two general methods I’ve used to get a better feel for how much I needed to buy.

Rule of Thumb for your Life Insurance Needs

Life Insurance Minimums are relative, and depend on things like geography and desired lifestyle. As a general rule of thumb, the industry recommends a multiple of 10-15 times your current income. This is a broad application; consider it a starting point! For example, in the event that you and your spouse pass away, providing a college fund for your children might cost more than you think! Also, if you or your spouse are the sole sources of income for the family, a lifetime of wages could be quite difficult to replace.

DIME Method Life Insurance

An acronym I’ve learned and used over the years is D.I.M.E. The DIME life insurance calculator helped me with a high-level view of what categories I should be thinking about when trying to come up with the amount of the death benefit. This is not a perfect science, but it does help to identify how much you need. In my opinion, it is easy to underestimate what you should buy. This acronym also doesn’t account for inflation, “end of life” expenses, and will certainly adjust depending on how many children you have as well as other sources of income, etc.

• D (Debt Obligations): Not including the mortgage, how much debt would your spouse be left with?
• I (Income considerations): What income are you trying to replace? Will your spouse also work?
• M (Mortgage(s)): What mortgages will need to be serviced? How much is left to pay?
• E (Education costs): Do you want to pay for your child’s education? If so, how would that be funded?

Closing Thoughts

My friend, I’d like to encourage you to seriously investigate this and take a step forward today! Get some quotes (I recommend an independent, licensed insurance broker) and get the proper policies in place that will support and enrich loved ones in your life. Your family is counting on you.

Honesty and Questions

When the time comes to fill out the application, a word to the wise: make sure, to be honest, and complete when filling out the application. Don’t be afraid to call the company, ask direct questions and investigate what doesn’t make sense. Consult a trustworthy professional with technical questions to address any unique tax or other financial questions. I also recommend paying an attorney to review any questions related to your Living Trust. An attorney will be able to capture your intent and set up a legal framework within the Trust.

My friend, GREAT WORK on the progress so far! But don’t stop with this step!