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A life insurance policy states that you will pay premiums to an insurance company over time, and, in exchange, the company will pay a lump sum amount to a designated beneficiary upon your death. The money from your life insurance policy can help pay bills and help support your surviving family members’ living expenses. You may need to adjust the amount of your life insurance policy related to major life events, like buying a home, getting married, or having a child.
There are two main types of life insurance policies:
Whole (or universal) life insurance policies are considered permanent. As long as you pay the premium, the policy is in effect. In addition to paying a benefit upon your death, whole life insurance policies also have an investment or savings component. This means that you accumulate cash value over the life of the policy, so you can borrow money from these types of policies if you need to.
Term life insurance policies are in effect for a certain period of time, or term. If you have this type of policy and pass away during the term that the policy is in effect, the insurance company will pay a benefit. If you live past the time that the policy is in effect, the insurance company won’t pay a benefit or give you a refund.
Term life insurance policies are usually less expensive than whole life insurance policies. This is because term life insurance policies only cover a set amount of time, while whole life insurance policies are intended to be permanent and because part of the money you pay is put away for savings.
When you buy a life insurance policy, you select an amount of money that will be payable at the time of your death and you name the person or persons who are to receive that money (these are known as your “beneficiaries”). You may also have the right to determine whether that money will be paid in a lump sum or in a series of payments.
All of these choices depend on what you want the insurance to do for you and your dependents. Most people buy life insurance to provide financial security for their families upon the death of the insured person. If this is your reason, the first step in calculating how much insurance to buy is to identify your dependents’ likely financial needs. If you are married, in a civil union, or have a significant other, you will want enough coverage to minimize your spouse’s or partner’s financial need after you are gone. If you have dependent children, you may want to help pay for their college tuition and other expenses. If your annual living expenses such as a mortgage on your home, personal or car loans, or property taxes are fairly high, you will need more insurance than someone whose home mortgage is fully paid for.
You may also want enough coverage to ensure that your dependents do not have to pay for your final expenses, such as hospital bills and burial costs.
Next, you should make a list of all the sources of income and assets your family would have if they were without you right now. This list can include cash in checking and savings accounts, the value of any stocks and bonds you own, your home equity, and benefits from social security. Check to see if you already qualify for group insurance. If you do, consider taking advantage of it and adding the face amount to your current assets. Do not forget to include the ability of other members of your family to earn a living.
The final step is to compare the total of your income and assets with the total of your dependents’ anticipated expenses. Ideally, you should buy enough life insurance to make up the difference between what your dependents would have if you died today and what they actually would need. However, it is important to buy only as much life insurance as you can afford. Buying a policy you cannot afford and then losing it because of your inability to pay the premiums is good money thrown away.
One final consideration: the amount of insurance coverage you need to protect you and your family while you are young is different from the amount you need later in life. If you already have a life insurance policy that you bought years ago, you ought to take another look at the policy as well as at your own needs. Perhaps your circumstances have changed dramatically since the policy was purchased. You may need to purchase additional insurance or may be able to reduce coverage to meet your current needs. Review your life insurance policy regularly to make sure it still meets your needs.