The Benefits of Life Insurance Policies
Life insurance is a contract between an insurance policyholder and an insurance company, where the insurer promises to pay a sum of money to a designated beneficiary upon the death of the insured person or after a set period. Life insurance policies are legal contracts that specify the terms and conditions of the coverage, such as the amount of the death benefit, the premium payments, the duration of the policy, and the exclusions or limitations of the policy.
Life insurance can provide many benefits to individuals and families who want to protect their financial security and well-being in case of unexpected events. In this article, we will explore some of the main benefits of life insurance policies, such as:
- Income replacement for dependents
- Debt repayment and estate planning
- Final expenses and funeral costs
- Living benefits and cash value
- Tax advantages and incentives
We will also discuss some of the factors that affect the cost and availability of life insurance policies, such as:
- The type and amount of coverage
- The age and health of the applicant
- The lifestyle and occupation of the applicant
- The underwriting and rating process
- The market conditions and competition
Income Replacement for Dependents
One of the most important benefits of life insurance is that it can provide income replacement for dependents who rely on the insured person’s earnings. This can help them maintain their standard of living, pay for their living expenses, and achieve their financial goals.
To determine how much life insurance coverage one needs to replace their income, a common rule of thumb is to multiply their annual income by 10 to 15 times. However, this may vary depending on factors such as:
- The number and age of dependents
- The current and future expenses of dependents
- The existing assets and savings of the family
- The inflation rate and interest rate
- The expected growth rate of income
For example, a person who earns $50,000 per year and has two young children may need more life insurance coverage than a person who earns $100,000 per year and has no dependents. A person who has a large mortgage or other debts may also need more life insurance coverage than a person who has no debts.
A term life insurance policy is usually the best option for income replacement, as it offers a fixed amount of coverage for a specific period of time, such as 10, 20, or 30 years. Term life insurance policies are typically cheaper than permanent life insurance policies, which last for the entire lifetime of the insured person.
Debt Repayment and Estate Planning
Another benefit of life insurance is that it can help repay debts and plan for estate taxes. This can reduce the financial burden on the surviving family members and ensure that they inherit the assets that the insured person intended.
Some common types of debts that life insurance can help repay are:
- Mortgage loans
- Car loans
- Credit card debts
- Student loans
- Personal loans
- Business loans
If these debts are not repaid by the insured person before they die, they may become the responsibility of their spouse, co-signer, or estate. This can reduce the amount of money that their beneficiaries receive from their life insurance policy or other sources.
Some common types of estate taxes that life insurance can help plan for are:
- Federal estate taxes
- State inheritance taxes
- Capital gains taxes
- Probate fees
- Legal fees
- Administrative fees
If these taxes are not planned for by the insured person before they die, they may reduce the value of their estate and affect their beneficiaries’ inheritance. For example, in 2023, the federal estate tax exemption is $11.7 million per individual and $23.4 million per married couple.
A permanent life insurance policy is usually the best option for debt repayment and estate planning, as it offers a lifetime of coverage and a cash value component that can grow over time. Permanent life insurance policies include whole life, universal life, and variable life policies. These policies have different features and benefits, such as:
- Whole life: A fixed premium, a fixed death benefit, and a guaranteed cash value that earns interest at a fixed rate.
- Universal life: A flexible premium, a flexible death benefit, and a cash value that earns interest at a variable rate.
- Variable life: A fixed premium, a flexible death benefit, and a cash value that can be invested in various subaccounts, such as stocks, bonds, or mutual funds.
Final Expenses and Funeral Costs
A third benefit of life insurance is that it can help cover final expenses and funeral costs. These are the costs that are incurred after the death of the insured person, such as:
- Medical bills
- Funeral arrangements
- Burial or cremation
- Cemetery plot or urn
- Memorial service
- Obituary notice
- Death certificate
- Travel expenses for family members
The average cost of a funeral in the U.S. However, this cost can vary depending on the location, the type of service, and the personal preferences of the deceased or their family. For example, a funeral with a viewing and a burial can cost more than $10,000 in some areas, while a direct cremation can cost less than $1,000 in others.
If these costs are not covered by life insurance or other sources, they may have to be paid by the surviving family members or the estate of the deceased. This can cause financial stress and emotional distress for the bereaved.
A final expense insurance policy is usually the best option for final expenses and funeral costs, as it offers a small amount of coverage for a low premium. Final expense insurance policies are also known as burial insurance or funeral insurance policies. These policies are typically permanent life insurance policies that have simplified underwriting and no medical exam requirements. They are designed for people who are older or have health issues that prevent them from getting other types of life insurance policies.
Living Benefits and Cash Value
A fourth benefit of life insurance is that it can offer living benefits and cash value. These are the benefits that the insured person can access or use while they are still alive, such as:
- Accelerated death benefit: This is a feature that allows the insured person to receive a portion of their death benefit in advance if they are diagnosed with a terminal illness or a chronic condition that requires long-term care.
- Cash value: This is a component of permanent life insurance policies that accumulates over time and can be accessed by the insured person through withdrawals, loans, or surrenders.
- Policy dividends: These are distributions of surplus earnings that some mutual life insurance companies pay to their policyholders on an annual basis.
- Riders: These are optional add-ons that enhance or modify the coverage of the life insurance policy, such as disability income rider, critical illness rider, or long-term care rider.
These living benefits and cash value can provide financial flexibility and security for the insured person and their family. They can help them cope with unexpected expenses, emergencies, or opportunities. They can also help them achieve their financial goals, such as saving for retirement, paying for education, or starting a business.
However, these living benefits and cash value also come with some drawbacks and limitations, such as:
- Higher premiums: Permanent life insurance policies that offer living benefits and cash value usually have higher premiums than term life insurance policies that do not.
- Fees and charges: Accessing or using the living benefits and cash value may incur fees and charges from the insurance company or the government, such as surrender charges, loan interest, withdrawal penalties, or taxes.
- Reduced death benefit: Accessing or using the living benefits and cash value may reduce the amount of death benefit that the beneficiaries will receive when the insured person dies.
Tax Advantages and Incentives
A fifth benefit of life insurance is that it can offer tax advantages and incentives. These are the benefits that reduce or eliminate the tax liability of the insured person or their beneficiaries, such as:
- Tax-free death benefit: The death benefit paid by the life insurance company