What goes through your mind when you hear life insurance? For some, it’s an expensive burden that one has to bear for the rest of their life and thus does not seem sustainable, especially with the availability of retirement plans, bonds, stocks, and even pensions.
But in the event of untimely death, what happens to your family? If they are dependent on you, how would they meet their needs or settle the financial obligations of any businesses you’ve left behind?
The choice to take out a life insurance policy or not is a tough call to make. Though it is a valuable asset that supports your beneficiary’s finances when you are no more, it may not be suitable for everyone.
In this article, we’ll explore the benefits and drawbacks of life insurance, what it costs, and the right conditions needed to make it worthwhile.
What Exactly is Life Insurance?
A life insurance policy is a long-term contract between an insurance company and a policyholder, guaranteeing that the policyholder’s beneficiaries would receive a sum of money (death benefits) in the event of the policyholder’s demise, as long as the policyholder makes regular premium payments to the insurance company.
But there’s much more to life insurance policies than just death benefits.
Life Insurance as Part of Financial Planning
Having a financial plan is necessary for anyone looking to achieve long-term financial goals. It helps to properly utilize your income, navigate expenses, and mitigate risks. Financial planning involves evaluating your current financial realities, assessing your lifestyle choices, and creating budgets that align with your short-term and long-term objectives.
A sound financial plan requires regular reviews, especially when life-changing events occur, such as starting a family, death, or changes in income patterns that affect one’s ability to save up for emergencies.
With a whole life insurance policy included in your financial plan, you can prepare against future life-changing events and fulfill long-term financial objectives like sponsoring your children’s education, growing wealth, enjoying retirement, leaving a legacy, and so on.
Whole life insurance has a savings component that allows your policy to accumulate cash value, which can be used at any point to meet or subsidize your needs in emergencies. This article provides the added advantage to investing in life policies — immediate access to money for your present needs while still catering to future needs.
Benefits of life insurance policies
- Financial cover for dependents:
The foremost objective of a life insurance policy is to cater to your beneficiaries in the event of death. The policy therefore prioritizes accumulating as many death benefits as possible with the amount of premium you pay, to provide financial security for your dependents long after you’re gone.
- Relieves funeral burden: With a life insurance policy, you can take care of your burial and other expenses associated with your funeral without burdening your family. This is highly advantageous since they could be too emotionally fragile to handle financial responsibilities at that point in time.
- Creates an inheritance: The death benefits paid out from your life insurance act as an inheritance for your beneficiaries; providing them with much needed resources should times get tough down the road.
- Tax benefits: With a life insurance policy, your beneficiaries won’t have to pay tax on the money they receive from the insurance payout. That is, the death benefits you accumulated while alive are all tax-free. This makes the policy a great choice when looking to pass on an inheritance to your loved ones, especially if you already have taxable assets that your beneficiaries would have to pay for.
- Business continuity: Beyond benefits for individuals, life insurance policies can also be strategically used to ensure business continuity by providing funds for a smooth transition upon the owner’s death. These funds can help payoff debts, facilitate ownership transfer, or provide support for the surviving business partners or family members.
- Coverage for health conditions: Depending on the type of policy, you can get coverage regardless of existing health conditions or medical history. This is suitable for individuals who find it difficult to obtain insurance based on their health. With life insurance, you can have policy add-ons that are specific to covering your health, while still enjoying all other benefits that come with the policy..
- Access to cash value: Another significant benefit of life insurance is the cash value component of the policy which provides policyholders easy access to funds with lesser interest rates than traditional financial institutions. Depending on the type of life insurance policy, this component would be available for owners to use to finance their current expenses while the policy still accumulates death benefits and possibly, dividends.
Drawbacks of life insurance
- Cost: Life insurance policies are generally more expensive than other policy types. And depending on the type of life insurance, whether term life, whole life, or universal life, the premiums can be quite expensive for the average household, especially families on a tight budget or with fluctuating incomes.
And since the premiums are paid regularly for the entirety of one’s life, it could prove to be a financial burden in the later years when health conditions set in and other age-related circumstances creep up to affect your earning potential.
- Complex nature: To fully enjoy life insurance’s benefits, you may need an open mind for creative money moving. It is a lot more difficult to understand in relation to other policy types, and it has a lot of terminology, conditions, and limitations you need to understand before signing the contract.
- High risk on returns: Some types of insurance policies only cover a fixed period in your life. If you happen to outlive that period, no death benefits would be paid out, and you risk losing all the investments made so far in the policy. In some cases, you can get back your premium, and in others, you can extend the coverage period. However, the implications of your life insurance expiring vary according to your policy type, and depending on what you’ve chosen, the policy could seem like a waste of money and a risk rather than an investment.
- Coverage limitations: Since life insurance policies generate large sums of death benefits that must be paid out upon the insured’s death, some companies, and policy types have limitations in place to specify the types of death they would cover.
- Potential for policy lapse: Life insurance premiums are to be consistently paid over a long time. If any premium is not paid on time, there is a high risk of losing all your coverage.
- Policy rigidity: Life insurance policies are long-term contracts that need to be honored by both parties; the policyholder by paying premiums and the insurer by accumulating the death benefits to be paid out to beneficiaries.
Once in effect, there is little to no flexibility in changing the policy terms even if your financial circumstances change later in life and you need to modify your policy. Such policy modifications would be very difficult to achieve and could attract penalties.
Cost of life insurance
One major concern about life insurance is its costs. While the policies have been proven to be beneficial in providing financial security for your loved ones, they often come at a cost that lends to its misconception as an exclusive investment for a few people.
The premium costs typically depend on several factors such as age, health conditions, lifestyle, among others that play a huge role in your earning potential and lifespan. Thus, owning a life insurance policy at a cheaper cost with the right conditions -young, no pre-existing medical conditions, and whatnot is possible.
Factors that Affect Life Insurance Premiums
Since insurance companies are obligated to pay death benefits whenever a policyholder dies, they set premium rates according to a set of predetermined factors that contribute to the policyholder’s lifespan. Some of these factors are:
- Age: Age is the most fundamental factor that affects how much your premiums cost. The older you are, the more expensive the premiums cost since you’re closer to the maximum life expectancy age and they would be more likely to pay out death benefits within a shorter period. Your 20s and 30s are considered the best time to kickstart your life insurance policy as your premiums would be cheaper than if you were to start much later in life.
- Health: Another crucial factor that affects premium costs is your health status. Most insurance companies require extensive medical checkups before you can be insured, to account for any illnesses that could affect your lifespan. Those pre-existing or current health conditions are then reflected in higher premium costs.
- Occupation: Insurance companies also take your job into consideration when setting premium costs. Suppose you work in an accident-prone industry, like construction, your premiums would be higher than someone who works in a lower accident-prone industry.
- Lifestyle: An eventful life with risky hobbies or habits might lead insurers to charge you with higher premiums. Having hobbies such as skydiving, mountain climbing, and habits such as smoking or heavy drinking could lead to higher premiums. On the other hand, if you engage in activities that improve your health like fitness exercise, you could have lower premiums.
Asides these factors, the premiums you’ll have to pay for your life insurance are also influenced by the type of policy and additional features that come with it.
Types of Life Insurance Policies and Their costs
- Term life insurance: This is the most affordable type of life insurance and the most popular insurance policy in the market. It covers only a specified period like 10 or 20 years, and its basic nature contributes to its lower premium cost. With the right financial strategy, you can maximize this policy at a cheaper price.
- Whole life insurance: This type of permanent life insurance provides coverage for as long as the policyholder lives. It operates a savings component that allows the owner to borrow against the accumulated cash value at minimal cost, while still generating wealth in the policy. This savings component along with its longer duration contributes to the expensive nature of its premium costs.
- Universal life insurance: This is another type of permanent life insurance that is generally more expensive than term life due to its longer coverage period. It takes the benefits of whole life insurance and combines it with the flexibility to adjust your premium payments and its resulting amount of death benefits.
Other costs to consider
Asides from premiums, there are other costs associated with life insurance policies:
- Underwriting fees: These are the monies paid to insurance companies when starting your policy. It covers the costs they incur in processing your application and determining your premiums.
- Policy Administration Fees: Some insurance companies charge this fee to manage your policy.
- Surrender charges: These are fees that are applied if you cancel your policy before a specific time. The fees will be deducted from the money in your policy upon payout.
- Riders: These are additional coverage options that can boost your policy, such as accidental death riders, combo riders, and so on. They, however, come at an additional cost to your premiums.
When is life insurance worth it?
Deciding whether to invest in a life insurance policy or not depends on your personal circumstances. However, there are certain situations where it is beneficial to own a policy, such as when:
You have dependents
The core offering of a life insurance policy is providing financial support to your beneficiaries when you are no more. They could be your spouse, children, siblings, or anyone dependent on your income, and the money can then be used to meet their needs and provide financial stability in the event of untimely death. The death benefits are also tax-free, which ensures they do not bear any burden in accessing the funds.
You have significant financial obligations
Life insurance policies are also valuable if you have debts or other obligations to fulfill. It grants you peace of mind knowing that with the policy payout when you die, your debts can be cleared off without burdening those you care about. Also, if fully maximized, the policy can help you regain financial independence and pay off those debts while still alive.
You have assets to pass down
It is beneficial to own a life insurance policy when you have significant assets or estates you wish to pass down to your future generations. The policy can serve as an investment, and be designed to minimize tax liabilities. It also ensures the assets are distributed according to your wishes.
When is life insurance not worth it
There are certain circumstances when owning a life insurance at that point in time may prove less than worth your while
You have a tight budget
Life insurance policies are long-term commitments and a single payment default can result in you losing all your investments made so far in the policy. If you are tight on money or don’t have a stable source of income, it would be best to invest in other options rather than starting the policy and opting out when you can no longer afford it. The same applies to if you suddenly come into a large sum of money but your regular income is not enough to sustain the premium payments.
You don’t have significant financial obligations
If your financial standing is okay and you don’t foresee any major financial obligations in the near future, it might not be the best use of your money to invest in life insurance — after all, there would be no debts to pass on to your beneficiaries. Also, depending on the type of life insurance, the policy can only be fully maximized when you use the cash value component. But if there are no significant expenses driving your need for it, you won’t be able to enjoy its benefits.
Read Also: Is Life Insurance Worth It?
Some alternatives to life insurance policy
Before choosing life insurance as a financial strategy for your short-term and long-term goals, there are some alternatives to consider.
- Traditional investments:
Stocks, bonds, mutual funds, and exchange-traded funds (ETFs) among others, are the common financial instruments anyone can invest in. They yield interest, dividends, and profits on the amount you invest.
These instruments are usually the first investment options people turn to when starting out on their financial journey, so they are great alternatives when life insurance is too complex.
- Retirement plans: Retirement plans such as 401k and IRA allow employees to make pre-tax or after-tax contributions to a plan where their money accumulates till retirement age.
This can be a great alternative to life insurance policies if you wish to enjoy financial stability when you are no longer earning income.
- Savings account: At times, a good ol’ savings account is all you need to cover your unexpected expenses and financial obligations. It doesn’t come with the burden of paying regular premiums, and you have the freedom to adjust how much you contribute and how often you make deposits.
- Mortgage life insurance: Also known as mortgage protection insurance, this policy pays your mortgage debt if you die. It is usually purchased when you buy your home, and it sets your lender as the beneficiary. This policy type is useful if you don’t want your family members to inherit mortgage debt in the event of your untimely debt.
Life insurance can be a valuable tool in achieving your financial goals. For many individuals, its tax-free death benefits are the major reason they invest in the policy. For others, it’s the cash value component which is a vehicle to financial independence, that piques their interest.
Nonetheless, you have to consider your financial standing, needs, and goals before deciding if life insurance is worth the investment. Working with a financial advisor who can help you find the right life policies that suit you and your financial goals is advisable.
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