Understanding What Is Life Insurance And Why You May Need It
What really is life insurance?
Life insurance and related financial subjects tend to be complex with an arcane world of their own, in fact they even have their own language.
Without a proper understanding of the subject, many who may need the benefits afforded by the service, simply avoid using and it, and the uninitiated are often taken advantage of and often persuaded to purchase unnecessary services.
The time-honored definition of life insurance is that it provides for a stipulated sum to be paid to a beneficiary upon the death of the insured person. In return, the owner of the policy agrees to pay a stipulated amount, either at regular intervals or in lump sums.
Life insurance is a way to form or accumulate capital that is paid to the beneficiary as death benefit. This amount is termed as the face value of the policy. The capital formed or benefit derived can be used to produce other goods, or it can also be used to produce income.
Life insurance produces capital on the demise of the insured, but depending on the type of insurance, capital may also be produced by borrowing against the accumulated cash reserves known as the cash-surrender value, or by using paid- up dividends that are paid by the insurance company. The capital can then used to provide income streams.
Your personal situation should help you to determine whether this is an appropriate vehicle to create capital that can be used for a variety of purposes including providing supplemental retirement income, or protection for your family.
Types of life insurance policies
Nothing in life, is really as simple as it may sound and there are several types of policies and and equal or larger number of things you can do with them.
When you buy term insurance, you only purchase protection. The premium paid provides coverage for a specified term or number of years. There are no living benefits from term insurance, because no cash reserve is built up. As a result, there is usually no cash-surrender value and no capital is formed before the demise of the insured.
There are three important components of the term insurance policy.
- The premium or cost to the insured
- The face value or the amount of the benefit to be paid on death of the insured
- The term or length of the coverage
As if to keep things as clear and simple as possible, policies are often sold with various combinations of these components.
Whole life insurance
Whole life provides for a level or graded premium, and can pay dividends and cash value included in the policy guaranteed by the company. Guaranteed death benefits and cash values, fixed and known annual premiums are some of the advantages of whole life insurance. In addition, you can borrow from the cash reserve without paying taxes, as it is considered as a loan provided the required stipulation is met. The death benefit is reduced by the amount that is borrowed.
The primary disadvantages of whole life are that the premium are inflexible and the internal rates of return may not be as competitive as other alternatives. In some cases, paying higher premiums can increase the death benefit.
The dividends from whole life insurance cannot be guaranteed and may be historically different. Premiums are much higher than term insurance in the short term, but cumulatively all things are equal if policies are kept engaged through normal life expectancy.
Varieties of Whole life insurance
Whole life policies also comes in different flavors, and each should be examined to determine which is appropriate for you.