What Is Life Insurance and How Does It Work?
Life insurance was first thought of to protect the income of families, especially young families just starting out, in the event of death of the head of household. But today, life insurance is used for many other reasons, including wealth preservation, estate tax planning and even to cover funeral and burial expenses.
Life insurance provides you with the opportunity to protect yourself and your family from repayment of debts, providing for a surviving spouse and children, paying off the mortgage and providing for the children’s education
Life insurance is an excellent financial planning tool. Life insurance is not for everyone. In fact insurance companies ask that you have an insurable interest. That is to say, you have others who financially depend on you. The very rich do not need life insurance as much as a young family starting out with low net assets, a high mortgage and young children to raise. However wealthier people may use life insurance as a form of wealth management and for tax planning.
First you must decide how long of a period you will need life insurance protection for.
A lot will also depend on your personal situation, your current income level and living expense, savings, standard of living and financial goals of your family.
A standard rule is you should buy life insurance for approximately 6 to 10 times your annual salary.
Then decide what type of insurance best suits your needs.
Type of Life Insurances
There are many forms of life insurance protection. The costs, structure and durations can vary widely between different types of policies.
Whole Life Insurance Plans
Whole life insurance plans offers guaranteed insurance protection for the entire life of the insured. These policies have a saving portion with a built in “cash value” component. While this may seem an attractive feature to many, the savings part accumulates at a very low rate of interest. It does however accumulate tax free until you withdraw, then the earned income part is taxed as income. On death, only one feature is paid out. The death benefit. If you do take the saving portion before death then you automatically surrender the death benefit. This is an expensive form of insurance because of the savings feature. Your premium remain level for the life of the policy. This type of insurance is known as a participating whole life policy. The built up cash portion of the policy may be accessed in times of need but there are restrictions and conditions. Read your insurance contract carefully as contracts do vary.
Universal Life Insurance Plans
Universal life plans have a more flexible premium schedule. There is also some flexibility in the level of its cash value and amount of insurance as both may be adjusted. The cash value part of the policy earns interest at a rate set by the insurance company.
Variable Life Insurance Plans
Variable life insurance plans combine the insurance and savings features but with an added growth potential element of investment funds.
As part of the insurance an investment account is created, comprised of various investment funds within the insurer portfolio of funds. The policy may invest in an equity fund, a money market fund, a bond fund or a combination of these. The investment growth fluctuates according to market forces whereby the cash value and death benefits also fluctuate.
Variable Universal Life Plans
This plan is a combination of some of the features of universal life with variable life which gives the flexibility of adjusting; premiums, amount of death benefits and the choice of investments. All the investment choices remain with the policy owner. This means that the death benefit value may vary depending on the growth rate of the investments.
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