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Life insurance is intended to compensate the beneficiaries of a policyholder in the event of the insured person's death. The death benefit can be used to reimburse a family for the deceased person's lifetime earnings or to pay off any debts or business expenses that they left behind.
Even though the fundamentals of life insurance are straightforward, determining whether or not you need a policy and how much coverage you need can be challenging. Here's what you need to know about life insurance so you can make an informed decision.
How Life Insurance Works?
There are three major characters of life insurance policies:
- A policyholder or an owner.
- The individual whose life is insured (usually, but not always, the policyholder).
- The beneficiaries who receive the death benefit (can be one or more).
When the covered individual dies, life insurance pays a death benefit to the beneficiaries in return for the policyholder's premium payments. Since the chance of death increases when you get older, buying life insurance when you're younger is usually less expensive.
Term and permanent life insurance are the two major forms of life insurance.
Term life insurance lasts for a set period, usually between one and thirty years, and only pays out the death benefit if the policyholder dies during that period. This type of policy provides no advantage to your beneficiaries if you outlive the term. Term life insurance is typically the most affordable form of life insurance.
Permanent life insurance provides coverage for the rest of your life. As opposed to term life insurance, the insurer charges higher rates, but premiums will stay the same even though the risk of death rises over time. This is because a percentage of the “extra” money you've paid to the insurer accumulates as a cash value, which you can use over the policy's existence.
As a result, this form of life insurance can be used as an investment vehicle, providing the policyholder with a possible source of income later in life.
Also Read: Types of Life Insurance
Why Buy Life Insurance?
There are many common reasons for buying life insurance, including:
- To replace the policyholder's income and the income of any dependents who rely on it.
- To cover the costs of a funeral and other final expenses.
- To leave a financial inheritance to heirs.
- To cover the cost of estate or inheritance taxes.
- To make a charitable contribution to a favourite cause.
Who Needs Life Insurance?
While not everyone requires life insurance, it is important to determine if you do. If any of the following scenarios apply to you, you may require life insurance:
You Have Dependents
The most popular reason for purchasing life insurance is to safeguard your dependents from a loss of income. If you have a partner, children, or other adult family members who are financially dependent on you, your life insurance benefit can give your family the ability to weather the financial impact of your death.
You Own a Business
Business owners may require life insurance to ensure the survival of their business after their death, to provide heirs with the funds needed to dismantle or sell the company.
You Carry a Great Deal of Debt
If you have borrowed a loan and you die, the insurance company will then pay your debt premiums so that your family does not go through a financial crisis.
Also Read: Is Life Insurance an Investment?
How Much Life Insurance Do You Need?
The amount of life insurance you need is determined by the reason for your need.
Enough to Support Your Family
People who have dependents are often required to buy a life insurance policy that is a multiple of their annual earnings. This rule of thumb can be used to quickly calculate a death benefit that will cover income for many years. However, it's a good idea to use this rough estimate as a starting point before crunching the numbers to see how much your dependents would need.
What Your Heirs Need for Your Business
If you're buying business insurance, figure out how much money your heirs will need to take over or sell the company, how much you'll need to replace a key employee if you die, and how much any co-owners will need to buy out your share.
Enough to Clear Your Debts
If you're worried about leaving debts behind, you can calculate your death benefit based on the time it would take to pay off your debts after you die. Those that want to leave money to pay for their burial and other final costs should estimate their insurance needs by filling out a funeral pricing checklist.
Less Common Life Insurance Needs
Aside from the obvious reasons for having life insurance, a policy may also help with a variety of less common requirements, such as:
Purchasing a child's life insurance will guarantee that the family will be financially secure in the event of the child's death, but this is a rare occurrence.
Replacing Retirement Benefits
Though life insurance is usually sold to cover an insured's income during their working years, some retirees will opt to retain a policy after they retire to replace any lost retirement income for the benefit of their spouse or dependents.
Insurance as guaranteed returns option
Some people choose to purchase specific life insurance policies that have guaranteed returns. However, the cost of these plans is extremely high. When opposed to conventional life insurance plans, certain people can think of other investment opportunities where they can gain high returns with less investment.
Is Life Insurance Worth It?
Since so many of the insurance calculations are based on your circumstances, financial status, and future expectations, the decision to purchase life insurance is a personal one. Even if you don't have any dependents, own a business, or have a lot of debt, you should consider having life insurance. That's because the cost will rise as you get older, so now is probably the best time to buy a policy.
Furthermore, even the best planners can't predict the financial consequences of your death, so life insurance can offer a measure of financial security for your loved ones.
When it comes to buying life insurance, thinking about the possible financial problems that might occur after your death may help you address the questions about whether to buy it when to buy it and how much to buy it.