When considering insurance as a means for financial protection, two main issues must be considered and resolved:
- Your ability to accept the financial risk inherent in insurance policy protection, and
- Your willingness to weather the volatility that sometimes accompanies insurance policies’ value development
There are two main reasons for purchasing insurance policies:
- To protect your financial well-being
- To accumulate cash
- And: a combination of the two
Insurance as a source of financial support for dependents
Insurance can be an excellent tool for providing financial support to the surviving family members. Funds from insurance policies can be used for the typical household expenses of paying bills, maintaining mortgage payments, purchasing food, clothing and health care, and can also be applied to education, day care, legal fees, or business costs.
Insurance to service debt
Insurance is also an effective means for providing resources to pay off a mortgage, vehicle loans, credit card debt, and debts such as college or business loans. Death does not terminate the estate’s obligation to pay back these debts, and an insurance policy could be very useful for preserving your survivors’ finances.
Insurance for personal uses
Insurance policies can also be a great resource during your lifetime. Cash value life insurance policies can potentially accumulate cash you can use for any purpose through a policy loan, or policy termination if circumstances warrant. If you terminate your policy, you would pay taxes on the funds you receive, possibly at a favorable rate.
Assessing your personal needs
Initially, you and your insurance advisor or financial planner should analyze your need for insurance to determine if life insurance fits well into your estate’s strategic plan. The key focus will be to understand the result of your family’s financial situation if the main financial contributor were to die. This analysis of your family’s needs will be a review of the death’s effect on income, existing assets, indebtedness, and living expenses in the future.
Insurance policies can assist with retirement needs, estate and tax planning, educational support for family members, etc. A careful review will determine if your situation would benefit from insurance, and if so, how much should be acquired and what type of policy is best suited for your purposes.
Insurance company risk?
Your advisor should recommend purchasing insurance only from absolutely sound insurance companies. Insurance companies are rated by independent services that assess the financial strength of these companies, and their ability to pay claims. Some of the best rating services are Standard & Poor’s, AM Best, and Moody’s. Your advisor should recommend purchases with high ratings from these companies.
Two types of policies
Term insurance provides only financial protection and has no cash value component. Upon your death, the insurance company pays your beneficiaries.
Term insurance is like renting. You pay rent, and when you leave, you take no equity with you. It provides only financial protection and has no cash value component. Upon your death, the insurance company pays your beneficiaries.
Cash value policies are like owning a home. You can build equity, and when you sell your home, you may even make a profit. They provide a death benefit, and after a period of time, cash value may have accrued and can be loaned to you, or paid out when the policy is terminated.
While there are many other types of polices available, they are all a variation of these two basic types. The right type for you depends on your circumstances.