What Is a Life Insurance and Why You Need It

2011-04-22 Brooklyn spring 050
Creative Commons License photo credit: Violette79 

This is a guest post by Andre, who is part of the team that manages Australian Credit Cards, a credit card comparison service with an extensive personal finance blog.

 Life insurance is basically a policy that people purchase from a life insurance company. Think of it as a financial safety net; it contracts the insured and the policy owner, so that when the insured dies, the designated beneficiaries of the policy holder can have the claim to the agreed payouts.

 You’ll have to understand what life insurance is all about before you begin to realize why you need one. There are two types of Life insurance and each with its own subtypes:

 TERM INSURANCE

Term Life Insurance forms the foundation of every life insurance policy. It provides life insurance coverage for a specified length of time in exchange for a specified premium- in the event of death and nothing else. This means the insurance company only pays you the promised amount if you die within a fixed number of years. The policy does not accumulate cash value, and when the policy reaches its deadline, the coverage disappears.

Various insurance companies offer term insurance based on three important factors: the face amount or protection benefit, which can remain constant or decline, the premium to be paid which can remain level or increase, and the term of the coverage term which can be for one or more years.

There are three common types of term insurance:

1. Level Term policy has the premium locked in for a period of time for more than a year and can be budgeted long term.

2. Annual renewable term is a policy that lasts for one year but the insurance company will issue a policy of lesser or equal amount regardless of the insured’s insurability and with a premium placed for the insured’s age at that time.

3. Mortgage Insurance is an insurance policy which protects the policy owner for losses due to the default of a mortgage loan. The face amount usually equals the mortgage amount on the policy holder’s residence, so the mortgage will be fully paid if the insured dies.

PERMANENT LIFE INSURANCE

Permanent life insurance is wherein the policy is the life of the insured; when the policy expires, the payout is assured and the policy increases cash value. The face amount of any life insurance policy is the amount of money the insurance company promises to pay as a death benefit if the insured suddenly dies while the policy is in effect.

 The four basic types of permanent insurance:

1. Whole life coverage. This policy protects you for your entire life and not just for a specified period. Your death benefit and premium will usually remain the same. It can also build cash value, and is tax-deferred until you withdraw or borrow against it.

2. Universal life coverage. Along with providing a death benefit, it also includes a savings vehicle. It’s like mixing a tax-deferred savings account, which also accumulates interests, with a term life insurance policy.

3. Limited-pay. In limited pay, the insured is given a specified period of time in which to pay the premium. When the time period passes, a premium will not have to be paid anymore, but the policy will still be in effect.

4. Endowments.The premium paying period in this type of permanent life insurance is shortened, and the insurance amount is paid within a certain period or when the insured reaches a specific age. This is why endowments are considerably more expensive than either whole life or universal life.

Now that you are oriented with the basics of life insurance, you will also have to know why you need it. Regardless if you have dependents or don’t really need to protect anyone or anything else, there are many reasons of how buying a life insurance can be beneficial to you. Here are some examples:

Mortgage protection

Taking out a mortgage is already a frightening prospect as it is. What more if you die suddenly, and you are the household’s only breadwinner. The person you are living with will have to continue the payments or they would be homeless. If you have gotten a mortgage insurance policy, which mostly are designed nowadays to pay out the entire amount of your original mortgage, regardless of how much you owe, you will not have passed on this problem.

Income replacement

When you die, your income dies with you. And with it goes the regular cashflow to pay your expenses. Protection insurance such as a life policy can be claimed to replace the lost income so the remaining dependents or survivor can maintain the same standard of living.

College funding

Life insurance can help fund your children’s college education even when you are already long gone from this world. If you die, the death benefit may be invested and likely grow the needed amount by the time your children enters college.

Other expenses

The last thing you want is to burden your dependents with all your present and future expenses. Your credit card debts, the car installments, and just the daily cost of living for your family, will be difficult to cover in the event of your sudden death. A Life insurance can be used to plan for final expenses such as potential medical bills, burial cost, and funeral expenses.

Peace of mind

Knowing that you have life insurance eases your mind and makes you confident that you can continue making your legacy even after your death.