What is Life Insurance? Life insurance is an agreement between you (the insured) and an insurer. Under the terms of a life insurance contract, the insurer promises to pay a certain sum to someone (a beneficiary) when you die, in exchange for your premium payments.

Why would I need life insurance?

Replace Lost Income:

The most common reason for buying life insurance is to replace the income lost when you kick the bucket. As an example, say that you work, and that your income is used to support yourself and your family. When you die, and your paychecks stop, the life insurance proceeds can be used to continue to support the family you've left behind. Think for a moment what would happen if tomorrow, you or your spouse does not make it home and the phone rings with the phone call you never expect and are never prepared for. What is the financial state you want to leave your family with if that phone call arrives in your home tomorrow?

Pay Off Debt:

Another common use of life insurance proceeds is to pay off any debts you leave behind. For example, mortgages, car loans, medical bills, Starbucks card, and other credit card debts are often left unpaid when someone dies. These obligations must be paid from the assets left behind. This can deplete the resources that your family needs. Life insurance can be used to pay off these debts, leaving your other assets intact for your family to use.

For A Business Owner:

Life insurance can be a great tool for specialized business applications, such as funding a buy-sell agreement. Under a buy-sell agreement, life insurance can be used to provide cash for the purchase of a deceased owner's interest in the business.

Savings Vehicle:

Finally, life insurance can be a savings tool. Some types of life insurance policies may actually make money for you, as well as provide the benefits described above. This can help you with long-term financial goals.

What determines your life insurance need?

Your life insurance needs change as your life changes. When you are young, you may not have a need for life insurance. However, as you take on more responsibility and your family grows, your life insurance needs will increase. You should periodically review your needs in order to ensure that your life insurance coverage adequately reflects your current needs.

Estimating life insurance needs

There are several simple methods that you can use to estimate your life insurance need. These calculations are sometimes referred to as "rules of thumb" and can be used as a basis for your discussions with your insurance professional.

Income Rule

The most basic rule of thumb is the income rule, which states that your insurance need would be equal to 10 or 15 times your gross annual income. For example, a person earning a gross annual income of $60,000 should have between $600,000 (10 x $60,000) and $900,000 (15 x $60,000) in life insurance protection.

Income plus expenses

This rule considers your insurance need to be equal to 5 times your gross annual income plus the total of any mortgage, personal debt, final expenses, and special funding needs (i.e., college). For example, assume that you earn a gross annual income of $60,000 and have expenses that total $160,000. Your insurance need would be equal to $460,000 ($60,000 x 5 + $160,000).

Life Insurance as a Savings Vehicle

Cash value life insurance provides both death benefits and a savings feature. When you buy a permanent or cash value policy, part of your premium pays for the life insurance protection and part goes toward the savings component. As you pay your premiums the savings portion is invested, and the principal and earnings accumulate as your cash value.

You are not required to leave the funds in the policy, however. You can sometimes withdraw from or borrow against the accumulated cash value. You can then use the withdrawn or borrowed funds to finance your retirement, pay a child's college tuition, or assist a child with a down payment on a house, among other things. This type of insurance can be a valuable asset, a great way to save money on a regular basis and also provide your family with the protection of Life Insurance.

Types of life insurance policies you can use to save

Whole life
A whole life policy, insurers usually invest the funds in long-term fixed-rate securities (bonds, for example) that provide the policyholder with modest returns of perhaps 3 to 5 percent. Additional returns may be achieved through dividend distributions (if applicable), but these returns are not guaranteed and depend on the insurance company's overall performance.

Variable life
With a variable life policy, you choose how to invest the premiums from the investment choices available in the policy. The funds are invested at a variable rate of return. Since you control how the funds are invested, you can choose more aggressive investments if the markets are flourishing. A variable life policy is an appropriate choice if you can tolerate the higher degree of risk. However, variable life returns depend on market conditions. Therefore, while you'll receive returns when the market is soaring, your returns will drop when the market falls. Another point with Variable policies is to ensure you know all the costs associated and build into the management of the policy.

Universal life
With universal life, the insurer invests the savings portion of your premium in a fixed-rate account that is subject to change at regular intervals. You have no control over how the funds are invested. These investments can yield fairly attractive returns when rates on fixed investments are rising. However, while you generally receive interest at close to market rates, you can't easily predict the long-term return. Because universal life policies typically allow you to raise or lower your premiums on an annual basis, you can increase your contribution when the insurer is offering a higher return. This flexibility with premium payments is one of the central advantages of universal life.

Variable universal life (VUL)
With variable universal life, you choose how to invest the premiums. You are given a number of investment accounts to choose from, ranging from conservative to aggressive portfolios. A VUL policy is a viable choice to consider if you can tolerate the higher degree of risk involved. However, be cautious, VUL returns depend on market conditions. Therefore, when the market falls, so will your returns. VUL typically allows you to raise or lower your premiums on an annual basis. This flexibility with premium payments is a key advantage of VUL.

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Why Accumulate Cash in my Life Insurance Policy?

Reason #1-Disciplined Cash Value Accumulation
In some types of permanent life insurance, you can increase cash value methodically with each premium payment. A portion of each payment is applied to the cost of insurance protection and other expenses; the balance is used to increase cash value. Where preferable, you can even have premium payments transferred automatically from your bank account. Since most people are not inclined to access their life insurance policies for casual or impulsive spending, this discipline can help you pursue long-term goals in small increments. In addition, many leading insurance companies guaranteed your cash values based upon an interest rate of 4%.

Reason #2-Guaranteed Safety
In permanent life insurance, the life insurance company g u a r a n t e e s the cash value of the policy. That makes this type of life insurance useful for accumulating assets that you can't afford to lose, or don't want to risk.

Reason #3-Tax Advantages
Any increase in cash value is not currently taxed. Most policies offer "partial surrenders" that allow you to withdraw part of your cash value permanently. Such withdrawals are considered an untaxed return of your premiums, provided they do not exceed the total amount of premiums paid. It is only after withdrawals exceed total premiums paid that they are considered taxable income. Lastly, a death benefit paid to your policy beneficiary is not subject to income tax.

Reason #4-Coordination
By accumulating cash value in your life insurance policy, you coordinate two important t parts of your financial planning-asset accumulation and insurance protection. In some life insurance policies, it's possible to link your death benefit (face value) to cash value growth, so that insurance protection increases dollar-for-dollar with asset accumulation. This assures you that insurance protection keeps pace with inflation. Your financial professional can help you evaluate the benefits of accumulating assets through life insurance.

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