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Life Insurance

Learn about the types of life insurance available and industry practices.

Always keep an organized file for paperwork related to your insurance plan. [©Jupiter Images, 2009]
©Jupiter Images, 2009
Always keep an organized file for paperwork related to your insurance plan.

Life insurance is a fundamental part of financial and estate planning for millions of Americans. Most financial experts agree that life insurance is a necessary part of any comprehensive financial plan.

At the same time, not everybody needs life insurance, or may not need that much of it. Because life insurance only pays out upon the death of the policyholder, individuals should consider the needs of their dependents before overpaying for what could be an unnecessary premium.

Life Insurance Defined

A life insurance policy is an agreement stating that the insurer will pay a fixed amount of money upon the insured's death in exchange for premiums paid during the insured's life. In fact, life insurance is very similar to other types of insurance, such as car or health insurance, with one big difference: The insured person never sees any of the payout. That's because life insurance is only paid out after death, and only then to a designated beneficiary.

Who Needs Life Insurance

Not everybody needs life insurance. An unmarried person with no dependents, for example, probably doesn't need to spend money on life insurance premiums. An individual with a working spouse also may not need life insurance, as the money used to pay premiums could probably be better invested during the individual's lifetime.

However, somebody supporting numerous dependents or an unemployed spouse might find life insurance useful. Below are questions to consider when deciding whether or not life insurance is necessary:

• How many dependents do I have? The number of dependents will influence the amount and type of life insurance one would buy.
• How much money would my dependents need for living expenses? Even if an individual is married to a working spouse, the family will need to replace the lost income from the deceased somehow.
• Do I have enough assets to cover my funeral expenses and estate taxes? The upfront costs associated with a funeral can put a severe strain on one's family. Insurance experts suggest planning on at least $15,000 worth of insurance to cover funerary needs.

Types of Life Insurance

Once an individual has decided that he or she needs life insurance, the appropriate type of life insurance must be determined. This can be confusing, as there are a number of different options available.

Term Life Insurance

Term life insurance is a life insurance policy that pays out if the insured dies during the period (the "term") of the policy. The catch is that these terms are finite, and if the insured dies after the end of the term, no benefits are paid.

For example, if a $100,000 life insurance policy has a term of five years, the beneficiaries will only receive the money if the insured dies within the five-year span specified on the policy.

Term life insurance has some benefits. For younger people, term life insurance is far cheaper than permanent life insurance. This makes sense, since younger people would have lower odds of dying during the established term. Of course, as one gets older, premiums for term life insurance can go up dramatically.

Permanent Life Insurance

Unlike term life insurance, permanent life insurance does not expire as the premiums are met. As one would expect, permanent life insurance is much more costly than term life insurance - since everybody dies sometime, insurance companies are guaranteed to have to pay out benefits.

Besides the advantage of not expiring, permanent life insurance has the added benefit of acting as an investment vehicle. In general, premiums are based on how much risk insurance companies carry to cover an individual. Once that risk is covered - usually within the first few years of paying premiums - additional premiums are put into investment accounts managed by the insurance company. As the investment accounts grow, they yield dividends which are then given back to the insured.

Though this may seem like a tempting way to invest money, financial experts advise against using life insurance primarily as an investment, as there are far better investment options available.

There are many types of permanent life insurance, including "whole life insurance," "universal life insurance," "single premium life insurance" and "survivorship life insurance." For more information about life insurance options, check out the resources on the Insurance Information Institute's Web site, or speak with a life insurance representative to learn more about available life insurance options.

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