Circle Of Life Insurance – Life insurance can be an essential part of financial and legacy planning. When looking for coverage, you can find several products that fall into two main categories: term life insurance and permanent life insurance (also commonly known as term life insurance). Understanding the essential differences between these two master plans will help you make coverage decisions based on your needs and goals.
Remember that group insurance, policies that cover a group of people under one contract (for example, coverage offered through an employer), may differ from policies sold to individuals.
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What is term life insurance?
Term life insurance is purchased for a specific period of time such as 1, 5, 10, or sometimes up to 30 years. The cover expires at the end of that period, hence the name, and is therefore only paid out if the insured dies during the said period. If the insured survives the original policy term, renewal of cover may be an option, but premiums may be higher.
Circle of Life Insurance – Possible Economic Objectives:
Circle of Life Insurance; for a family, the need for parental life insurance arises from the following possible economic objectives:
- Have enough money to pay the mortgage and other debts in full to relieve the family of these payments. Note: Although mortgage rates are low, it is actually better to stick with the mortgage. Instead, invest the money you received from life insurance and then earn a monthly income for your mortgage payments. Note: Mortgage insurance1 is not recommended
- Give the surviving spouse an amount of money to take a few months off from work if necessary.
- Have an amount of money to fully fund the surviving spouse’s pension.
- Having an amount of money to fully realize the educational goals of the children.
- The main goal and greatest need are to have an amount of money (often referred to as an “income replacement fund”) from which a monthly income can be drawn to cover the family’s everyday living expenses (which may include new expenses for Daycare). This income, indexed for inflation, must be continued until all children are financially independent.
- Payment of Funeral Expenses.
- Make charitable contributions, if desired.
- The establishment of a long-term family trust for the benefit of children and grandchildren.
- An important concept is that the amount of money required to achieve these goals changes over time, and therefore the amount of life insurance coverage also needed changes; usually low.
- The blue bar graph illustrates from left to right how the need for life insurance may change over time.
On the far left, there is very little need for life insurance for a child.
For young adults (and the young at heart), the following three life events can happen in different orders for different people. In this example
- Marriage (or life in a free union) occurs first and may generate the need for life insurance if the new couple so desires.
- Buying a house and taking out a mortgage generally increases the need for life insurance, as most couples prefer the surviving spouse to keep the house.
- The greatest need for life insurance arises when parents expect a child to be the last/youngest child (see objective 5 above). The amount of money required to replace one parent’s net income for 25 years (indexed for inflation) is typically over a million dollars!
As the year passes, presumably2, the mortgage and other debts are gradually paid off, the children’s educational goals are gradually funded by PRAE contributions, and the children grow up on their own and approach financial independence.
During the parents’ retirement, the need for life insurance is much less (there may still be goals for life insurance to pay for income tax obligations, funeral expenses, charitable contributions, and to create a family trust for the descendants).
The red line shows how parents’ investments may i) grow while they work, and then ii) decline during retirement. There may come a time when parents become self-confident, meaning they have enough investments to meet all of their remaining financial goals (assuming they keep working until their planned retirement date).
Circle of Life Insurance – How Life Insurance Coverage Works
Term life insurance is perhaps the simplest and most straightforward life insurance option for many people. A death benefit can replace the income you would have earned for a period of time, such as until a minor survivor grows up. Or you pay off a large debt, such as a mortgage, so that the surviving spouse or other heirs don’t have to worry about making payments.
When exploring life insurance options, you may come across the word “cash value.” Life course policies do not generate cash value. Your premiums go towards your payment, making the cost to policyholders relatively lower than perpetual life insurance. However, some insurers have created term life insurance products with a “premium return” feature, where a portion of the premiums you pay are returned if a claim is not made before the end of the coverage period. These policies can be more expensive up front than standard term life insurance.
There are different types of term lives, including the flat term and the declining term.
• Term life insurance offers a death benefit that remains the same throughout the policy.
• Declining term life insurance policies reduce potential death benefits over the life of the policy, usually in one-year increments.
For more information about the different types of term life insurance, click here.
What is Whole Life Insurance or Permanent Life Insurance?
Permanent life insurance often called lifetime or cash-value life insurance, provides coverage for the life of the insured, as long as premium payments are current. Unlike term life insurance policies, these policies can accumulate cash value, which an insured or their heirs can access under certain conditions. As a result, premiums can be higher than with term life insurance policies. Lifetime products include several subcategories, including traditional real life, universal life, variable life, and variable universal life.
How does “cash value” work?
When you pay premiums for a permanent life insurance policy, they go towards the cost of insurance, your policy costs, and the creation of cash value. In the case of traditional life insurance policies, both the death benefit and the premium are typically designed to remain the same (level) over the life of the policy. However, insurance costs can really add up as you get older, especially if you’re over 80 years old.
Charging a premium that rises every year would make life insurance unaffordable for many seniors. Instead, the insurance company charges a higher premium during the coverage period than is necessary to pay claims in the early years of the policy. The company invests this money and, if necessary, uses it to top up the level premium to defer the cost of insuring older policyholders.
By law, when these “overpayments” reach a certain amount, they must be made available to the policyholder as cash value, accumulated in a savings account. Under certain conditions, the policyholder may withdraw or borrow against the accumulated cash value. It is important to remember that cash value is generally limited as a living benefit and remains with the insurance company when the insured dies. Any cash-value loan may reduce the death benefit.
Conclusion – Which One Is Right For Me?
Permanent or whole-life policies typically offer the benefit of lifetime coverage but may charge higher premiums than term-life products. Therefore, your death benefit may be less than a term life insurance policy for the same amount. People who choose whole life insurance likely prioritize certain features that suit their individual financial goals, such as the ability to plan consistent benefits and premiums and the potential for tax-deferred growth through the cash value component of your policy.