Think about life insurance sooner rather than later
If you're in your 20s or 30s and are taking the time to read this article, you're a forward-thinker.
According to the life insurance industry research group LIMRA, nearly 30 percent of millennials polled say that saving for a vacation is more important than purchasing life insurance.
Perhaps you're curious about how life insurance works and how it could benefit you and the people you love. Maybe you're a newlywed or a new parent. But whether you're married or single, a parent yet or not, buying life insurance is sound financial planning.
Before digging into the details, here's a quick glossary of words insurance companies use when describing policies:
- Term: This is essentially the period of time for which you're covered with life insurance. If you purchase a 30-year policy, for example, and pass away within that time frame, the insurance company will pay your beneficiary a lump sum. If you pass away on the first day of year 31, you are no longer covered.
- Premium: This is what you pay an insurance company, either monthly or annually, to maintain coverage.
- Beneficiary: This is the person who receives money from your insurance company if you pass away.
- Death benefit: Contrary to how it sounds, this is actually a good thing. Your death benefit is sometimes referred to as your "face amount." At a high level, it's the amount of money the insurance company will pay your beneficiary if you die. If you purchased a 30-year, $250,000 term life insurance policy, your death benefit, or face amount, is $250,000.
- Cash value: This is what insurance companies call the money you can accrue and eventually withdraw from your life insurance policy. Some policies, such as whole life and universal life, help you build some extra income for retirement.
- Rider: If your life insurance policy is a kitchen mixer, riders are the attachments that help you make pasta or curly fries. They are essentially add-ons that allow you to access your death benefit/face amount for other purposes, such as long-term care.
You may be familiar with the most basic kind of life insurance — term insurance. With a term policy, you agree to pay your premium for the length of your term. If you die during that time, your beneficiary receives a lump sum payment. If you don't, you and your insurance company shake hands and part ways.
The death benefit or face amount varies based on the size of your policy. Pro: It's the least-expensive option to protect your loved ones. Con: At the end of your term, you have not accrued any value.
You may have also heard of whole life insurance, which allows you to protect your assets and build a cash reserve to use later in life. The major pro for whole life is that you know you'll have money built up in your policy at the end of your contract. The con? Because of that guarantee, you have less flexibility in regard to your monthly or annual premium.
A third type of insurance, which could be considered a middle ground between term and whole, is universal life insurance. From a protection standpoint, it works the same way as term and provides a death benefit.
Choosing the right policy
What's different about universal life insurance is that it helps you accumulate extra income for retirement and allows you to adjust your premium according to your budget. You can choose to pay the minimum required to keep the policy working for you, or you can contribute more, depending on your financial situation.
At a very high level, here's how it works: A portion of your premium accrues interest over time. You can access the cash value you've built up in your policy for anything you want, but many people use it as a cushion for retirement, savings for college or a rainy day fund in case of an emergency.
Here are five things you should know when thinking about life insurance and choosing a product that makes sense for you.
1. It will never be cheaper than it is right now. You're young. You're healthy. Insurers love you and express that love with lower premiums. Some parents take advantage of this by buying policies for their children when they're very young, with the assumption their kids will one day take over those premiums. No one knows what the future holds, but buying a policy when you're young and healthy guarantees your insurability.
2. A cash-value policy is a long-term commitment. Universal life insurance policies offer a lot of value but are traditionally more expensive than term coverage. Before signing on the dotted line, it's important to weigh the costs and long-term benefit. Double check the numbers to make sure you can fund the policy appropriately, and think through how the policy will benefit you throughout your life.
It's also important to remember that your life insurance needs evolve over time. As your circumstances change (marriage, property, children, etc.), your policy may need to be adjusted, so it's good practice to reevaluate your coverage as part of your annual financial review.
3. It's beneficial at every stage of life. Some single professionals might think they don't need life insurance, because they are the only ones relying on their income. What they may not realize is that any outstanding debt in their name could have a profound financial impact on someone they love. For married couples or parents with additional dependents, life insurance can cover final expenses and help your family maintain their lifestyle should they pass away unexpectedly.
If you're a parent who has weathered the teenage years and have a son or daughter heading to college, you can use the cash value you've built up in the policy for college expenses. Bonus: Life insurance is not an included asset on the Free Application for Federal Student Aid (FAFSA).
Finally, although it may seem far away, you will stop working one day. The money you've accumulated in a universal life policy can help supplement other sources of retirement income. You can use it as a slush fund, to pursue a hobby, to travel more or to start a new business venture.
4. Your cash is yours (and your family's) to keep, tax-free. Cash-value life insurance policies have important tax advantages, either complementary to your other savings and investment vehicles or on a standalone basis. In a universal life insurance policy, the cash value grows tax-deferred. In most cases, it can also be accessed without a tax penalty via loan or withdrawal if an unexpected expense or emergency arises. Policy death benefits are also generally exempt from income tax.
5. It's customizable. There are a number of ways to configure a life insurance plan. Oftentimes, a combination of two policies — term and cash-value coverage — is an efficient way to maintain protection and flexibility up to and through retirement.
This makes sense particularly when you consider that the need for the death benefit varies over time.
People typically need more coverage when their children are young, and less as those kids become self-supporting adults. The term insurance can end after the children leave home, and the cash-value policy can stay in force to provide added flexibility during retirement.
As an alternative to long-term care insurance, certain policy riders can also be attached when the policy is purchased, which allow you to access your death benefit for nursing-home care or rehabilitation.
The most important thing to remember when choosing a life insurance policy is to pick a product that complements the various components of your retirement strategy. Armed with this information, you can decide for yourself what's best for you, your future and the people you love.
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