The most common reason for purchasing a life insurance policy is income replacement. For the rich, payment of estate taxes is another major purchase motivator.
The basic life insurance policy provides coverage for death by any cause, at any time, in any place, except for suicide within the first two policy years (one year in some states). Life insurance is designed to protect named beneficiaries against the sudden loss of income being provided by the insured.
The concept of life insurance, restoring affected parties to their prior economic position before the loss, has changed little in hundreds of years. Many regulations are designed to prevent gambling or speculating on the lives of strangers, so there must be “insurable interest” at the time the policy is placed into effect.
There are basically two types of life insurance: temporary (term life) and permanent (whole life and universal life).
Term life insurance provides death benefit protection and guaranteed rates for a specific number of years and only pays if the insured dies during coverage period. Term life policies are typically guaranteed to be renewable to age 90+ without medical underwriting, a feature that can become very important if the insured develops health problems towards the end of the initial rate guarantee period and cannot buy new coverage on the open market.
Typical term life rate guarantee period ranges from five, 10, 15, 20, or even 30 years.
Below is a series of frequently asked questions and answers regarding term life insurance:
When should I consider purchasing term life insurance?
Term life insurance is ideal for someone who has a temporary need for life insurance protection ranging from five to 30 years. Because of this flexibility, term life is enormously popular with families who have children (and expected educational expenses into the future) or where there is a mortgage or other future financial liability.
Term life insurance is also suitable for someone who cannot afford the higher premiums of a permanent life insurance policy.
Term life rates are now near or at all-time lows.
For example, a healthy 40 year-old male with no rateable impairments can purchase a 20 year, $500,000 term life policy for about $31 per month. A permanent policy for that same person would run about $225 per month.
Temporary need for life insurance includes the following situations – children’s college education, loan repayment or income replacement should death occur prior to retirement.
How does term life differ from permanent life?
Permanent life insurance is intended to provide protection for your entire life while term only provides protection for a specific period of time. Since permanent offers longer protection, premiums are generally more expensive.
Whole life insurance has a unique characteristic: a side fund of cash that builds up over time, called “cash value.” Some people think of this as a forced savings account, but such cash values never increase the overall payout value of the policy.
While it is convenient to be able to borrow against one’s cash value account from time-to-time, that loan has to be repaid or the eventual death benefit will be reduced.
Term life insurance has no cash value funds.
Another form of permanent life insurance is universal life. Universal life is highly flexible and may be set up with or without a cash value fund at the election of the policy owner.
Universal life also permits “premium skipping” although the rules on that can often bite an unknowing policyholder because the skipping of premiums always affects either the rate guarantee period or the amount of death benefit or both. Because of its flexibility, universal life can be somewhat complex to understand.
Are the proceeds of a life insurance policy taxable to the beneficiary?
Generally speaking, no. The proceeds of a life insurance policy are paid tax-free without affecting the income tax of the beneficiary. However, receipt of a life insurance policy proceeds can increase a person’s net worth and make them ineligible for certain government benefits.
Can an insurer cancel a term life insurance policy?
Yes, but only under certain circumstances. Fraud on the application gives an insurer a valid reason to cancel, so never lie or withhold information on a life insurance application.
Suicide within the first two policy years (one year in some states) represents an out for insurers a non-payment of premium always represents a cause for cancellation. As long as premiums are being paid on time, the policy will remain in-force for the prescribed period of time.
If you miss a payment, you will have 31 days in most states to catch up without the policy lapsing. This is known as the grace period.
Can I buy a life insurance policy and skip the paramed exam?
Yes. In recent years, life insurers have brought to market several new policies that do not require a paramed exam. These policies are generally available up to $400,000 and are underwritten using recorded phone calls, e-signatures or voice signatures.
These insurers then make instant lookups into a wide variety of databases, including Medical Insurance Bureau (MIB), prescription drug databases, state driving records, etc. Many are underwritten instantaneously, which is very convenient. But if you get declined trying to buy such a policy, expect to wait two to three weeks for the explanation to arrive via U.S. mail.