By Richard McGrath, CIC, LIA
Do you know enough to make informed decisions about your life insurance? To find out, take the following test. It should take only about five minutes to complete.
Last year, we invited readers to test their knowledge of health insurance. As we did then, we will present 10 statements, which you may answer as being true or false, followed by the answers.
Last year’s test was based on a national survey from LIMRA, an insurance trade group, which reported that nearly eight out of 10 consumers answered five or fewer questions correctly. Nearly 80 percent scored a 50 percent or less, and only one in 10 answered at least seven questions correctly.
Can you answer the following questions about life insurance correctly?
Question 1: Term life insurance is short for “termination” life insurance, because it can be canceled by either the insured or the insurance carrier at any time.
Answer: Term insurance provides protection for a specific period of time. If you die during your term of coverage, your beneficiary or beneficiaries will receive a death benefit as specified by the policy. If you die after the term expires, your beneficiaries receive nothing. The answer is “false.”
Question 2: Cash-value life insurance is the same as permanent life insurance.
Answer: Cash-value life insurance provides coverage throughout your life, as long as you do not cancel the policy and you continue to pay your premiums on time. Because it can insure you throughout your life, it is often called permanent life insurance. The answer is “true.”
Question 3: If you have employer-provided life insurance, you don’t need anything else.
Answer: To protect your family, experts recommend that the benefit equal at least five to eight times your income (some recommend 10 to 12 times your income).
Employer life insurance typically provides a benefit of one or two times your annual salary, not including commissions or bonuses. Employers may also provide the ability to purchase additional insurance, for a total benefit of four to six times your annual salary.
Even if your employer provides you with sufficient insurance, you may lose it when you leave your job. And, if you wait to purchase your own policy, premiums will increase as you grow older.
High-level executives sometimes negotiate for generous life insurance policies from their employers, but in almost every case, employer-provided life insurance will not provide the level of protection you need. The answer is “false.”
Question 4: Life insurance can also provide significant tax advantages.
Answer: You can use life insurance to build cash value on a tax-deferred basis. The cash that builds up in your insurance policy does not become taxable as income until you withdraw it from your account, which makes it similar to a 401(k) plan.
As with a 401(k) plan, your cash value will be invested and will continue to earn money, but there are no limits on how much you can invest in life insurance. Earnings are reinvested continuously without being subject to taxation, so you can take full advantage of compounding.
So, the answer is “true.”
Question 5: The only reason to purchase life insurance is to enable survivors to continue to afford their current lifestyle.
Answer: While the most important purpose of life insurance is to protect beneficiaries from the loss of your income, it may also serve other purposes. Cash-value life insurance is often used to pass on wealth to children or grandchildren, or to make charitable donations. When life insurance is held in a trust, it typically is not subject to income taxes or estate taxes.
Life insurance is also used in business succession planning. It can, for example, be used to provide funds to buy out the ownership interest of a deceased partner. The deceased partner’s family benefits and the business can continue operating without a financial hardship. The answer is “false.”
Question 6: You’re likely to live until you’re in your 70s, 80s or even 90s. It makes no sense to buy life insurance when you’re young, because you won’t need it for a long time.
Answer: The younger you are when you purchase your policy, the lower your premiums will be. Age is just one factor; the older you are, the greater your likelihood of developing a medical condition that will make life insurance much more expensive. In addition, if you purchase cash value life insurance, the younger you are, the greater the percentage of your premium that goes toward building cash value.
Keep in mind that we never know how long we will live. If you die without life insurance coverage, your survivors may not be able to afford their current lifestyle.
The answer is “false.”
Question 7: Your life insurance can only benefit your family after you die.
Answer: Permanent life insurance offers access to the policy’s cash value through withdrawals or tax-free loans. The funds can be used for a child’s education, retirement or other needs. The answer is “false.”
Question 8: Second-to-die life insurance is insurance that pays a claim if two people die at the same time.
Answer: Second-to-die insurance, also known as survivorship life insurance, insures two people’s lives and pays out a benefit after the second person dies. It may be used, for example, to protect a married couple when both spouses are financially independent, but want to make certain their children receive a benefit when they both die. The answer is “false.”
Question 9: Cash-value life insurance carries investment risk.
Answer: The answer is “true,” but the level of risk depends greatly on the type of cash-value insurance you purchase.
If you buy whole life insurance, the insurer will generally invest cash-value funds in long-term, conservative investments that provide modest returns. The policy holder may also receive dividends, but they are not guaranteed. The policy holder has no control over how funds are invested, but premiums are guaranteed to remain at the same level.
If you purchase universal life insurance, cash values are held in fixed-rate accounts and the policy holder has no control over how funds are invested. Interest rates credited to the cash values change regularly, but the policy holder generally receives interest at close to market rates. The policy holder can increase or decrease premiums each year.
With variable life insurance, the insured, rather than the insurance company, directs investments instock and bond sub-accounts that have the potential to provide a higher return than the conservative investments used for whole life and universal life. Front-end fees and other charges may apply and the cash value principal is at risk.
Variable universal life combines the insurance protection of universal life insurance with the investment aspects of variable life. It allows policyholders, within certain guidelines, to design their own policies by increasing or decreasing their premium payments and by increasing or decreasing the policy death benefits.
Question 10: You’re better off buying term life insurance, which costs less than cash-value insurance, and investing the difference.
Answer: Term life insurance is fine for people who cannot afford cash-value insurance. If, for example, you want to provide protection only until your children are grown and out of the house, you don’t need permanent life insurance.
However, keep in mind that the purpose of life insurance is to provide survivors with a source of income when you die. You’re most likely to die at an old age – and the older you are, the more expensive term insurance becomes.
Instead, you can lock in a premium today by buying cash-value insurance.
The investment aspects of insurance are an added benefit, because they can provide a source of retirement income or pay for other things, but they are not the reason for purchasing life insurance. Cash-value life insurance is the best way to protect your spouse or family in your senior years and it can provide a legacy for your heirs. Therefore, the answer is “false.”
We hope this test spurs you to take action and not be among the 40 percent of Americans who do not have life insurance.
Richard A. McGrath, CIC, LIA is President and CEO of McGrath Insurance Group, Inc. of Sturbridge, Mass. He can be reached at email@example.com.
This article is written for informational purposes only and should not be construed as providing legal advice.