Life insurance may secure the financial future for your family. Life insurance ensures that your dependents will have the financial resources needed to maintain their lifestyle. It is important that you understand your needs and the choices available.
Life insurance can be used to accomplish a variety of financial goals, such as funding retirement or education expenses. However, it is important to remember that the main purpose of life insurance is financial protection for your family’s lifestyle.
If your primary goals are something other than protection, you should consider what other financial products are available to meet those goals.
Your personal insurance agent and company are good sources of general information about insurance.
- Look in your local library for magazines or books on insurance or personal finance.
- The consumer affairs division of your state insurance department can provide useful information.
For information regarding life insurance or annuities, please contact:
Mihir Nag, Ph.D.
Life and Annuity Specialist
Learning the Basics
The best way to make an informed decision about buying life insurance is to become familiar with the basics. There are three life insurance basics that all consumers should consider:
- Start by considering how many people are financially dependent on you, what their major expenses are likely to be and whether you’re likely to leave them with substantial debts or taxes to pay on your estate. Life insurance can help on all of those fronts.
- Evaluate the two main types of life insurance: term and permanent. As its name implies, term life insurance pays a death benefit if you pass away within a specified time period. Permanent life insurance lasts your lifetime and also has the ability to build up cash value during the term of the policy.
- Understand the major factors that can affect life insurance premiums. Some are uncontrollable, like the age at which one purchases a policy or a serious pre-existing medical condition, like cancer or heart disease. Other factors are much more dependent on an individual’s behavior, like poor health habits (e.g., smoking and excessive drinking), driving record (e.g., accidents and Driving While Intoxicated citations), engaging in dangerous hobbies (e.g., sky diving, car racing or rock climbing) and even where one lives, since mortality rates in a geographic region may be used by life insurance companies to help establish premiums.
An important feature of life insurance is that there is no federal income tax on proceeds paid to beneficiaries.
How much life insurance do I need?
Before buying life insurance, you should assemble personal financial information and review your family's needs. Factors to consider include:
- Any immediate needs at the time of death, such as final illness expenses, burial costs and estate taxes;
- Funds for a readjustment period, to finance a move or to provide time for family members to find a job; and
- Ongoing financial needs, such as monthly bills and expenses, day care costs, college tuition or retirement.
One rule of thumb is to buy life insurance that is equal to several times your annual gross income, to allow your family the ability to continue their lifestyle for several years without hardship.
If you need to stop paying premiums, you may be able to use the cash value to continue your current insurance protection for a specific period of time or to provide a lesser amount of protection to cover you for as long as you live. Usually, you may borrow from the insurance company, using the cash value in your life insurance as collateral. Unlike loans from most financial institutions, the loan is not dependent on credit checks or other restrictions. You ultimately must repay any loan with interest or your beneficiaries will receive a reduced death benefit.
What are the advantages and disadvantages of term and permanent insurance?
- Initially, premiums are generally lower, allowing you to buy larger amounts of insurance at a younger age when the need for protection often is greatest due to debt.
- Good for covering specific needs that will disappear in time, such as mortgages or car loans.
- Premiums increase as you grow older.
- Coverage may terminate at the end of the term or may become too expensive to continue.
- Generally, the policy doesn't offer cash value or paid-up insurance.
- As long as the necessary premiums are paid, the policy will last your lifetime, or age 95 or 100, whichever is stated.
- Policy accumulates cash value that you can borrow against, or withdraw if needed.
- A provision or "rider" can be added to a policy that gives you the option to purchase additional insurance without taking a medical exam or having to furnish evidence or insurability.
- Premiums never change during the life of the policy.
- Higher premiums than term insurance which may not be as affordable.
- It may be more costly than term insurance if you don't keep it long enough.
How do I choose a company?
Before purchasing a policy, check the company's financial condition. You can do this by asking the agent. A number of insurance rating services rate the financial strength of companies. The A.M. Best ratings guide is available through the link on the IDOI website.
How do I choose an agent?
Collect the names of several agents (also called producers) through recommendations from friends, family and other sources. The following are some questions you may want to ask a potential agent:
- Are you licensed to sell life insurance in Indiana?
- Do you sell variable products also?
- If so, are you registered with the National Association of Securities Dealers?
- Check if an agent is licensed
- What company or companies does the agent represent?
- Does the agent have any professional designations such as:
- Chartered Life Underwriter (CLU)
- Life Underwriter Training Council Fellow (LUTCF)
- Agents who are also financial planners may have designations such as:
- Chartered Financial Consultant (ChFc)
- Certified Financial Planner (CFP)
- Member of The Registry of Financial Planning Practitioners.
- Is he or she a member of a professional association?
The major association for agents is the National Association of Insurance and Financial Advisors, Inc. (NAIFA). Through NAIFA's local associations, agents can attend educational seminars and can stay informed of trends in the business.
The agent you have selected will meet with you to discuss your life insurance needs. He or she will ask questions about family income and your net worth. Using the information you already have assembled about your financial situation, you should be prepared to discuss your insurance options.
In this initial meeting, be prepared to answer questions about your health (for example, age, medical condition, medical history, family history, personal habits). It is important that you answer these questions carefully and truthfully. You may also have to have some level of medical checkup as part of the application process.
Your Agent's Recommendations
Once you have discussed your financial needs and objectives with your agent, he or she will recommend the type of life insurance policy that will best suit your purposes. Most insurance companies provide a Buyers Guide to help you ask the right questions and select the proper life insurance for your needs.
Provisions or "riders" that provide additional benefits can be added to a policy. One such rider is a "waiver of premium for disability." With this rider, if you become totally disabled for a specified period of time, you do not have to pay premiums for the duration of the disability. Another rider, called an "accidental death benefit," provides for an additional benefit in case of death as a result of an accident.
A relatively new rider offered by some companies provides "accelerated benefits," also known as "living benefits." This rider allows you, under certain circumstances, to receive the proceeds of your life insurance policy before you die. Such circumstances include terminal or catastrophic illness, the need for long-term care or confinement to a nursing home.
Ask your agent for information about these and other policy riders.
"All consumers should remember to review their life insurance policy every year before paying their premiums and update it to reflect any major changes in their lives – like marriage, the birth of a child, divorce or the death of a spouse," said Insurance Commissioner Jim Atterholt. "Before signing up for any kind of insurance, consumers should check with our state insurance department to make sure the company offering the policy is legitimate, solvent and authorized to do business in Indiana."
Guide to Annuities
Annuities are forms of financial protection. An annuity is a contract written by a life insurance company to provide continuing income, typically for retirement. Payments, which are generally made on a monthly basis, are usually arranged to continue for as long as you live or for a stated period of time. Payments may begin at once or at some future date.
The annuity contract is often described as being the opposite of life insurance. It pays while you live; life insurance pays when you die. Actually, the two can complement each other. Instead of lump sum benefit payments, many life insurance beneficiaries choose to use their policy's proceeds to purchase an annuity.
You should tailor any decision to buy an annuity to your own needs. To do so, talk with a qualified life insurance agent or financial advisor.
Why People Buy Annuities
Many people buy annuities to give them retirement income for the rest of their lives. An annuity contract can also be a means of building assets for other purposes with a more limited time span.
Annuities can be used to fund an Individual Retirement Account. They also may be used in Keogh-type retirement plans for the self employed.
Types of Annuities
There are two basic types of annuity contracts. The kind of annuity you choose to buy determines when benefit payments will begin.
Immediate annuities are generally purchased by people of retirement age. Such plans provide income payments at once or soon after purchase. They are usually purchased with a lump sum payment.
Deferred annuities are plans under which you arrange to have income payments start at some future date. Interest builds up on the money contributed. Such plans are often used by younger people to save money for retirement. These plans have become popular in good part because of the tax-deferred buildup during the accumulation period, the time during which you pay money into the annuity contract.
- If you buy a deferred annuity with a lump sum, it is known as a "single premium deferred annuity".
- You can, however, pay for your deferred annuity over a period of years. Typically, this type of contract allows flexibility in premium payments. Except for the first year, premiums may vary from year to year, with no requirement that any specified amount be paid in any given year. Such a contract, called a "flexible premium retirement annuity," can be used as an Individual Retirement Account.
Under either form of deferred annuity, if you die before the annuity payments begin, the accumulated value of your contract is paid to your designated beneficiary.
You can also convert the cash value of your life insurance policy to an annuity. For example, if you are over 65 and your children are out of school and are financially self-sufficient, you may now feel you no longer need all of your life insurance coverage. Your life insurance policy probably contains an option allowing you to convert its cash value to a life-time income.
Some contracts let you borrow against your accumulated contract value. You may also be able to use the annuity as collateral for a bank loan.
With deferred annuities, insurance companies guarantee the interest that will be credited to your contract value. Every contract contains a long-term guarantee. The company, typically, credits interest at rates higher than the guarantee, as its investment results permit, and it may provide short-term guarantees at rates higher than the long-term guaranteed rate or rates.
With an immediate annuity, you will be told at the time of purchase exactly how much money you will get and when you will get it.
How About Taxes?
When you buy a deferred annuity, the interest credited to your contract builds up free of current income tax.
Once you start to receive a monthly payment, however, the government begins to tax the accumulated interest. Part of each payment will be interest and will be taxed as ordinary income. The other part is principal and is not taxable. This is true of both deferred and immediate annuities.
If you withdraw money from your annuity before age 59 1/2, the interest you have earned on your contributions must be withdrawn before the principal and is subject to personal income tax. In addition, there is a ten percent penalty tax on such premature withdrawals, except in certain circumstances, such as disability or death.
You may want to consult a tax advisor well in advance of retirement for more information about the taxation of retirement income. Also, the Internal Revenue Service has helpful booklets on the subject.
Most states require insurance companies to pay a tax, commonly at two percent, on the annuity premiums they receive. A company will either charge you for the tax separately or include it in the premium amount.