This article about the basics of life insurance, The purchase of life insurance may be one of the most important decisions you ever make in your financial life. However, it’s a decision that most of us will put off until something happens that hits close to home. That’s really not too surprising since we all have a built-in mechanism that avoids thinking about death. But that kind of procrastination can be devastating to a family or business.
Cost of Procrastination
- Families agonize
- Business Flop
- Dreams get ruined
Let me explain there are three basic questions to be asked and they have to be asked and answered in the right sequence or all the answers will be wrong.
The three questions are
- Do I need life insurance?
- How much do I need?
- What kind should I buy?
Do I need life insurance?
The quick and easy answer is that someone will suffer financially when you die you need life insurance. That could mean your family perhaps aging parents or maybe even your business partner and employees. Sometimes we might be inclined to say well they’ll be okay and maybe that’s true. But it’s important to remember that we don’t get a chance to change your minds once were gone. We need to face reality well we can do something about it.
|Good for temporary needs||Cost increases with age|
|Affordable||Must re-qualify when the term expires.|
|Lifelong coverage||More costly than term when initially purchased.|
|Premiums are often level for life.|
|Accumulates cash value|
How much should I have?
Some experts recommend a rule of thumb that runs anywhere from 5 to 20 times your annual income. Obviously with that kind of spread the rule of thumb isn’t very helpful. So how do you determine if you need a $100,000, $250,000, $500,000 or more in life insurance coverage? The best way to figure out what you need is to have an insurance professional conduct what’s called a financial needs analysis. Here’s how it works you’ll start by gathering all of your personal financial information and estimating what your family members would need after you’re gone to meet their financial obligations. To calculate this figure you’ll need to think through three types of expenses
1.) Immediate expenses
Such as Funeral expenses, uncovered medical costs, taxes and outstanding debts you want to be paid when you die such as automobile debt and credit card bills.
2.) Ongoing expenses:
- Health Care
Which is basically money for your family to live on for a specific period of time to help pay for everyday living expenses like food clothing transportation mortgage or rent payments.
3.) Future expenses
such as money to fund a college, retirement savings plan after you figured out your family’s needs you’ll then want to tally up all of the resources that you’re surviving family members can draw on to support themselves. This would include things like your spouse’s income savings you’ve accumulated and any life insurance you already own.
Calculating your Life Insurance Needs
|Current and future financial||–||Spouse’s earnings, savings, Investments and life Insurance you already own||=||Life Insurance Needed|
The difference between your family’s needs and the resources in place to meet those needs is your need for additional life insurance.
Let me share a story with you that illustrates the value of properly calculating the need for life insurance in a very powerful way. Early in my career, I was working with the physician in Southern California, who is very busy and didn’t give me anytime to help them determine the amount of life insurance that was appropriate for his family. Rather he asked me to simply sell them $500,000 policy. I complied with this request only to read several months later they had been killed by a hit-and-run driver while changing the tire on the side of the freeway. I took great pride in being able to deliver the much-needed cash to the family. Only to be shocked to learn that the doctor had nine children three of whom were in college at the time. I distinctly remember sitting in a room with his wife and all of his children when they collectively asked me, is this all there is.
I felt bad that I hadn’t found some way to break through to the man and convince them to approach the process the proper way. I promised never again to shortcut the process and to always calculate the real need for life insurance. I never have a shortcut the process sense and you shouldn’t. Either there are no do-overs with life insurance there’s nothing more important than buying the right amount of coverage and you need to get it right the first time.
So after you’ve figured out how much you need you’re now ready to focus on what kind of life insurance buy?
There are two fundamental considerations that go into answering this question.
Type Depends On:
- How is long coverage needed?
- Your Budget.
First how long will you need the insurance? And second how much money do you have in your budget for this expand?
Type of Life Insurance
- Term Insurance
- Permanent Insurance
How long you need a question will help you decide if you want term insurance or permanent insurance term insurance last for a specified period of time, say 5 years or 10 years, 20 or maybe even 30 years. If you only need is for funds to pay off a 20 or mortgage at your death a 20-year term policy would probably be the answer for you.
Or if you’re concerned about providing funds to take care of your aging parents in their later years a 5 or 10-year term policy might do the job. The shorter the period of time the policy last the lower the premium. But once the term period is over you’ll have to pay the considerably higher price to maintain it, if you want to do so.
And you may well have to take another insurance physical to qualify all over again. That means your health must still be good and you haven’t taken a piloting skydiving or vehicle racing declining health or a dangerous job or hobby can significantly increase the cost of insurance. And sometimes can make coverage unaffordable or even unavailable.
That leads me to the second kind of insurance permanent insurance permanent insurance is what the name implies it’s with you for life. No matter how old you are, when you die the premiums are projected to remain level over your lifetime. And in some cases can be designed to stop at retirement while your coverage remains in force for life.
Permanent policies build a cash surrender value that is available if needed in the event of emergencies, opportunities for college for the kids. Of course, these benefits come with a price. The initial premium for the permanent insurance is 3 to 10 times higher than it is for an equivalent amount of term insurance. So if your budget is limited be sure you buy as much as you need even if it’s all term insurance, but if you have some room in your budget it usually makes sense to include some permanent insurance in your program.
And as time goes on it will probably make sense to convert some of your term insurance to permanent insurance. You know one of the biggest mistakes I see my clients make is underestimating how long they’ll need life insurance. This was painfully true immediately for many after the.com bubble burst in two thousand all of a sudden you had people who experienced a significant loss in their retirement assets. And they were no longer able to retire on time.
Life insurance fills the financial gap that exists between your financial needs and your financial realities. The fact that people had to work additional year’s necessitated owning life insurance for a longer period of time and many were caught unprepared.
By owning both types of life insurance term and permanent you’re better prepared for the unexpected things that happen in life. Let’s face it our financial lives never go as smoothly as the financial press would have us believe.
So far we’ve looked at life insurance from the context of your personal needs. However, life insurance is a tool that is also utilized by almost every small business in America. Businesses especially smaller closely held businesses utilize life insurance to protect their companies in case of the premature death of an active owner.
Business Uses of Life Insurance
- Fund a buy-sell agreement
- Buy time to replace an owner or key employee
- Equalize an Inheritance
- Pay estate taxes.
Life insurance is used to purchase the deceased partner’s interest and provide an income stream to the surviving family.
Life insurance also may be left to the company to provide a financial caution to the company in the case of a loss of an active owner or key employee.
Life insurance is also utilized to provide cash to equalize the inheritance of a family where only one of the children inherits the company.
And finally to provide cash to pay federal estate tax. That the company doesn’t have to be sold to pay the tax liability.
These uses of life insurance keep businesses in business, families financially secure and Americans employed. There you have it a properly designed life insurance program is essential to a sound financial plan as a strong foundation is to a home. Do it right in the future secure?
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