Tuesday, March 17, 2009

Life insurance explained

One of the most basic things you can do to protect your family is buy life insurance. If you don’t have it, you need to consider getting it, and the sooner the better. It can be confusing, though, so here’s a basic guide on the types of insurance and what to consider before you buy.

There are three basic types of life insurance. Death proceeds paid to beneficiaries are income tax free, but the policy value is part of the decedent’s estate. If the estate is large enough, there could be estate tax implications.

Value within a policy, in whole or universal life, accumulates tax-free until it is surrendered, when the gain – if any - is subject to income taxes.

Term Life is a simple contract where an insurance company pays your named beneficiary a specified dollar amount if you die during the covered period. It typically runs year to year, and can be purchased with guaranteed renewal options. Term life is the cheapest form of life insurance and often recommended for young families.

Whole Life operates much like term life, but the policy accumulates a cash value, which can be withdrawn or borrowed against in the future. Because there’s a “savings” component to the policy, premiums cost more. Advocates point out that term life only pays if you die, whereas whole life can build value for other purposes. There is often a low minimum rate of interest guaranteed to the cash value each year, with some promise of higher rates if the insurance company earns more. Death benefits are paid to a named beneficiary for as long as the policy is in force.

Universal Life combines the cash accumulation features of whole life with a palette of mutual-fund-like investment options. Here, the accumulation fund can be invested in stock or bond markets via managed funds. Over time, this more sophisticated investment approach could result in higher policy cash values. Like other policies, death benefits are paid to a named beneficiary for as long as the policy is in force.

There are hundreds of variations on each type of policy, and most can be customized to a family’s unique situation. It’s important to choose an agent with comprehensive knowledge and experience. The quality of insurance companies can vary widely, too, so conduct some due diligence at the library or on the Internet before signing anything.

Commissioned agents sell most life insurance, so it is important to understand exactly what you are buying and all fees and expenses involved. Reputable professionals won’t be offended by your questions. Avoid sales pressure and vagueness about terms or conditions.

The sole reason to buy life insurance is to protect family members who would suffer without your income. Be wary of complicated schemes or outsized promises.

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