Getting life insurance

Life insurance is a contract with an insurance company in which you pay a certain premium payment each month in exchange for the company’s promise to pay a much larger amount to those named as beneficiaries (receivers of insurance benefits) in the event of your death. Life insurance policies are designed to protect your family from financial hardship.

Life insurance decisions generally become more important to people as they get older. During your student years, your marital or parental status will probably be the biggest factor in deciding whether or not you need this type of insurance.

Protecting or investing
Most people buy life insurance to guarantee income to their children or spouses and protect their estates following the insured’s death. A second reason for purchasing it is to build additional financial security and flexibility through “permanent” life insurance.

Term life insurance
Term life insurance is the kind of policy you’ll select if you want to provide coverage for your dependents over a set period of time. If you die while the policy is in effect, your beneficiaries receive a fixed amount of money (the “death benefit”), and they don’t have to pay federal income taxes on this money. How the money is paid can be determined by the policy owner or left up to the beneficiaries. Generally the beneficiaries make the decision after they become eligible to receive the money. Term life insurance does not accumulate a cash value.

If you were to die suddenly from an illness or accident, term insurance could help cover day care, food and medical expenses for your child. How long the money lasts depends on the amount of the death benefit and your survivors’ living expenses. A one-year renewable term policy may cost several hundred dollars for death benefit coverage in the $250,000 range.

Term coverage can also be purchased for periods of as long as 20 or 30 years, although shorter policy periods may be a better for college students who have temporary guardianship of a child. When you stop paying, the policy is terminated. Unlike permanent life insurance, you will not get anything back for the payments you made when you stop the policy. This is essentially like “renting” life insurance.

Permanent life insurance
Permanent life insurance policies come in several varieties and sometimes have higher initial premiums than term policies. Permanent life insurance provides death benefit payments to your dependents after you die, but also offer the additional benefit of accumulating a cash value as you continue to make your premium payments while you are alive. Death of the policyholder is not necessary to take advantage of accumulated cash value (the "living benefit") during times of financial need.

Permanent life insurance begins to look more like a financial asset as it increases in value over time. Some ways to take advantage of the growing cash value of a permanent policy include the following:

• You can borrow money against the policy’s accumulated cash value. These loans do not have to be paid back with cash. The insurance company basically pays itself back by subtracting the amount you borrowed from the death benefit. Borrowing against your policy, however, can leave your dependents without adequate death benefit protection.

• You can annuitize the cash value of permanent insurance. An annuity is a special kind of insurance contract between you and the insurance company where you pay into an income tax deferred account over a period of time (or even in a lump sum), and the insurance company pays you a guaranteed income, including interest, at some point in the future. Annuity payments are usually arranged to provide retirement income. The interest paid is often at a fixed rate, set each year by the annuity issuer. Converting $20,000 of life insurance premium payments into an annuity is somewhat like creating an interest-bearing savings account which the company returns to you in preset increments. You do not have to pay taxes on the growing $20,000 account until the insurance company begins sending your payments. Also, if you should die while getting retirement payments, your beneficiaries can receive the balance of the annuity. However, if you annuitize the cash value of the life insurance, the life insurance death benefit goes away.

• If you decide to terminate your permanent life insurance, you can get some of its cash value back all at once—possibly more than you put in. You can use the accumulated cash value of terminated permanent life insurance as you please, but in this case you may have to pay taxes on a portion of it.

Permanent life insurance is much more complex than term insurance. Policies can be structured in a number of different ways. With some, the premium amount and death benefit stays the same as long as you carry the insurance. Other policies allow you to adjust the amount of your premium or your death benefit to suit your financial needs.

If you want to learn more about life insurance as an investment, visit The American Council of Life Insurers Web site.