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Life Insurance Basics

This is not intended to be a professional insurance advice. :-)

What is life insurance?

Simply put, life insurance is an amount of money an insurance company pays to someone you name (called beneficiary) when you die. You can name anyone you wish as your beneficiary, your spouse, a person, a business, an organization. Your beneficiary can use some of this money to pay the expenses related to your death, and can invest the rest to generate income that will help replace your salary. This way you can protect your family against financial disasters.

How insurance works?

As the insurance consumer, you pay an amount of money, called a premium, to the insurer to transfer the risk. The insurer pools all its premiums into a large fund, and when a policyholder has a loss, the insurer draws funds from the pool to pay for the loss.There are mainly two major types of life insurance:

Term life insurance: Term life is the simplest and least expensive type of policy. A term life policy has only one function: to pay a specific lump sum to whoever you’ve designated, upon a specific event - your death. It’s pure insurance with no cash value. This means when the policy is over and you still alive, it won't have any cash value, you won't get any money back

Permanent life insurance (or cash-value) life insurance: This type of policy combines life insurance with a savings (cash value) account. Usually it will cost you more, because some of your money will be invested by the insurance company. The value of the savings account will grow over the years, and your policy will have a cash back value. This is the insurance type which is more popular in Europe.

Main differences between the two
major types of life insurance


The protection period of the two types of insurance differs. A term life insurance only gives you protection for a specified period of time, one, five or ten years, or even up to a specified age. It allows you to choose the exact number of years of protection, by continually renewing your existing term life policy until a designated year is reached. Permanent life insurance covers a long period of time, up to your entire lifetime.


The payment patterns of term and permanent insurance, or how much you pay every year in premium at various ages of life, is different. When you are young, term premium payments are relatively low. Premium payments go up with your age, because the older you are the more likely you will die within the protection period, and the insurance company is more at risk to pay after your death. This means the term insurance will cost you more and more every year as you get older.

On the other hand, when you are young, permanent policy premium payments are higher than term payments because some of the money is put into a savings program. Permanent policy premium payments are fixed and don’t go up with your age. This way as you get older, your yearly premium patments may be lower than rising term payments.

The extra premium paid in early years will be invested, grows and accumulates you cash value. The longer you keep the policy, the more money you put in, the higher its cash value it gets plus it will earn you interest, dividends or both.

Provided that the death benefits are the same, the “costs” of life protection calculated on the long run over the years should be almost the same for term or permanent life insurance policies, even if the payment patterns are different.


Flexibility, termination: You can terminate your term policy whenever you want by not renewing it. If you terminate your permanent policy earlier you are usually required to pay high charges called surrender charges.


Tax considerations: According to the IRS (Internal Revenue Service) tax code the earnings of a permanent policy are not subjected to income tax until they are not witdrawn. This is called tax deferral, you don’t have to pay taxes over the years until you decide to cash the insurance policy and withdraw your money. It is great, because this way the cash value of your policy will grow faster than any other savings (like your savings account, mutual funds etc.) which get taxed year after year. But don’t forget, your policy IS subject to income tax at some point in the future, when you decide to withdraw your earnings. If you don’t withdraw it during your life, after your death is usually tax-free to your beneficiary.

Which insurance is best for you?

You probably already asked yourself the question: do YOU need life insurance at all, or not. Good question. Who needs life insurance nowadays in America? Shortly: almost everyone. Here are a few possible scenarios to give you some ideas on how life insurance may relate to you, why you should consider getting one, regardless of your age, financial or family situation.


Single adults with no children or other dependents: You will need only enough insurance to cover burial expenses and debts, unless you want to use insurance for charitable or estate planning purposes.


Adult couple with no children or other dependents: If your spouse could live comfortably without your income, then you will need less insurance than the people with kids. However, you will still need some life insurance. At a minimum, you will want to provide for burial expenses, for paying off whatever debts you have incurred, and for providing an orderly transition for the surviving spouse.


Families or single parents with young children or other dependents: The younger your children, the more insurance you need. If both spouses earn income, then both spouses should be insured, with insurance amounts proportionate to salary amounts. If the family cannot afford to insure both wage earners, the primary wage earner should be insured first, and the secondary wage earner should be insured later on. A less expensive term policy might be used to fill an insurance gap.


Children: Children generally need only enough life insurance to pay burial expenses and medical debts. In some cases, a life insurance policy might be used as a long-term savings vehicle.


Retirees: There is less of a need for life insurance after retirement, unless it is to be used for other estate planning purposes. You will need some insurance to pay burial expenses, final medical costs, and debts.


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