No one wants to think about when “crap happens”, but the universe isn’t fair. It is better to be prepared than to get caught like a deer-in-the-headlights. This topic is a bit morbid, but one that should be contemplated. The purpose of life insurance is to replace your income for the people who depend on it, in the event of your death.
Basically, you are betting that you will die and the insurance company is betting that you will live. You’re gambling with an insurance company about whether or not you’ll die before a certain age.
In fact, most insurance companies send a nurse to examine your health prior to providing a quote.
The result is that If you lose the bet, you will be out thousands of dollars. If you “win,” your spouse and heirs get a handsome 6- or 7-figure payout upon your death.
Additionally, death benefits from all types of life insurance are generally income tax-free. This is one reason some people use it to pass on wealth (read on to learn how).
Life insurance proceeds can be used to replace lost potential income during the deceased’s working years.
The goal of life insurance is to provide a safety net for your beneficiaries (typically your spouse/children). The payout (known as the death benefit) helps to achieve the family’s financial goals. A few examples might be paying the monthly bills, helping with the mortgage balance, supplying support for college tuition, wedding costs, etc.
Typically, the amount of life insurance is based on the needs and goals of the owner. Meaning that the amount of coverage you will need depends on your specific situation.
The more children or out-standing debts (mortgages, car payments, credit card debts, number of kids wanting to go to college, etc.) the more your survivors will need.
Two Types of Life Insurance
Permanent (whole and universal) life insurance is generally more expensive than term life insurance.
Term Life Insurance:
Term life insurance provides protection for a specific period of time. You pay premiums for a specified term (usually 10, 20, or 30 years), and if you die within that term, the insurer pays your survivors a benefit.
The premium payment amount stays the same for the coverage period you select. After that period, you may be able to continue coverage but usually at a substantially higher premium payment rate.
Term insurance is similar to car insurance… If you stop paying the premiums, you will lose the insurance.
Beware, once you have stopped payments and are no longer covered, you may need to take another medical exam. Moreover, your premiums may change because you are now older and your health may have changed from when you first applied.
Whole and Universal Life Insurance:
Both whole and universal life insurance provide lifetime coverage. Moreover, you earn a guaranteed cash value in exchange or your premium payments. So what is the difference you ask? Read on…
Using Life Insurance to Transfer Wealth Tax-Free:
Universal life insurance is often used as part of an estate planning strategy to help preserve wealth to be transferred to beneficiaries.
This is because universal life insurance policies are flexible and may allow you to raise or lower your premium payment or coverage amounts throughout your lifetime.
Should you need to transfer more tax-free wealth upon your death, you ask your life insurance company to increase your coverage amount. This means that your premium will likely increase as well.
A Comparison of Life Insurance Policy Types:
Here is a great comparison table of how life insurance plans work, provided by Fidelity.
Term life Insurance to Pay-off Student Debt
Over 44 million Americans collectively hold $1.5 trillion in student debt. Nearly 70% of college students graduate with a significant amount in loans. Shockingly, the average student loan borrower has $37,172 in student loans, which is a $20,000 increase from 13 years ago.
If you have graduated with big student loan debts, that a parent cosigned for, you or your parent may want to get a life insurance policy on you to cover the balance of the loans.
A co-signing parent may have helped you take out loans, with the intent that you will be the one to pay them off. Your parents cosigned the loan with your best interest at heart because they wanted you to get an education.
Losing a child is supposed to be one of the worst events a person can live through. To make matters worse, being left with a huge outstanding loan on top of the loss of a child would be tragic.
To prevent this from happening, you can purchase just enough term life insurance to cover the outstanding debt. In your early 20s, this policy should be dirt cheap.
Note that you only need this insurance if your loans have cosigners. If you are the only signer on your loans, your parents cannot legally be held responsible for those debts.
A Word of Caution:
It’s important to note that: Although life insurance can be used to replace lost potential income, the benefit is paid at the time of death in a lump-sum payment.
Therefore, it is important that the beneficiary carefully reinvest and pay off debts in a strategic way.
A portion of the money should go toward paying off debt that has a higher than 5% interest rate (like credit card debt) and the rest should be reinvested.
The thought behind this method is that the stock market returns an average of 7% per year over any 40 year period, while the average inflation rate is around 2% per year.
In sum, the money would be better off being reinvested in the stock market than paying down any debts with an interest rate of lower than 5%. To create a safety buffer, you may consider paying off any debt with an interest rate of over 4%.
Remember to always set aside 6-12 months in an emergency fund prior to allocating the rest to reinvestment. There are many investment vehicles that produce income, such as dividend stocks, investing in private equity real estate companies, and REITs.
How Much Life Insurance Do You Need?
Here is a great video that explains how much life insurance you should consider purchasing by Investopedia.
Diversification is one of the most important aspects when deciding how to allocate your investment portfolio. Spreading out your risk amongst many different asset classes will help you weather the many inevitable storms to come. Your investment portfolio should include stocks, ETFs, fixed income assets, real estate, and other investment vehicles.
Like what you see? Stay a while!
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