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Are you need life insurance?

If someone depends on you financially, chances are you need life insurance.
Life insurance provides cash to your family after your death. This cash (known as the death benefit) replaces your income and can help your family meet many important financial needs like daily living expenses, mortgage payments and college savings. What's more, there is no federal income tax on life insurance benefits.

Most Americans need life insurance. To figure out if you need life insurance, you need to think through the worst-case scenario. If you died tomorrow, how would your loved ones fare financially?

Would they have the money to pay for your final expenses (e.g., funeral costs, medical bills, taxes, debts, lawyers fees, etc.)? Would they be able to meet ongoing living expenses like the rent or mortgage, food, clothing, transportation costs, healthcare, etc? What about long-range financial goals? Without your contribution to the household, would your surviving spouse be able to save enough money to put the kids through college or retire comfortably?

The truth is, it's always a struggle when you lose someone you love. But your emotional struggles don't need to be compounded by financial difficulties. Life insurance helps make sure that the people you care about will be provided for financially, even if you're not there to care for them yourself.

To help you understand how life insurance might apply to your particular situation, below we've outlined a number of different scenarios below. So whether you're young or old, married or single, have children or don't, take a moment to consider how life insurance might fit into your financial plans.

You're Married
Most families depend on two incomes to make ends meet. If you died suddenly, could your family maintain their standard of living on your spouse's income alone? Probably not. Life insurance makes sure that your plans for the future don't die when you do.

You're a Single Parent
As a single parent, you're the caregiver, breadwinner, cook, chauffeur, and so much more. Yet nearly four in ten single parents have no life insurance whatsoever, and many with coverage say they need more. With so much responsibility resting on your shoulders, you need to make doubly sure that you have enough life insurance to safeguard your children's financial future.

You're a Stay-At-Home Parent
Just because you don't earn a salary doesn't mean you don't make a financial contribution to your family. Childcare, transportation, cleaning, cooking and other household activities are all important tasks, the replacement value of which is often severely underestimated. Some surveys have estimated the value of these services at over $40,000 per year. Could your spouse afford to pay someone for these services? With life insurance, your family can afford to make the choice that best preserves their quality of life.

Your Kids Are Self-supporting and Your Mortgage is Paid Off
As the years go by, you may feel your need for life insurance has passed. But just because the kids are through college and the mortgage is paid off doesn't necessarily mean that Social Security and your savings will take care of whatever lies ahead. If you died today, your spouse will still be faced with daily living expenses. What if your spouse outlives you by 10, or even 30 years, which is certainly possible today. Would your financial plan, without life insurance, enable your spouse to maintain the lifestyle you worked so hard to achieve? And would you be able to pass on something to your children or grandchildren?

You're Retired
Did you know that depending on the size of your estate, your heirs could be hit with a large estate tax payment after you die (up to 48% of your estate depending on your state). The proceeds of a life insurance policy are payable immediately, allowing heirs to take care of estate taxes, funeral costs, and other debts without having to hastily liquidate other assets, often at a fraction of their true value. And life insurance proceeds are generally income tax free and can be arranged to avoid probate. Finally, if your insurance program is properly structured, the proceeds from your life insurance policy won't add to your estate tax liability.

You're a Small Business Owner
Besides taking care of your family, life insurance can also protect your business. What would happen to your business if you, one of your fellow owners, or perhaps a key employee, died tomorrow? Life insurance can help in a number of ways. For instance, a life insurance policy can be structured to fund a "buy-sell" agreement. This would ensure that the remaining business owners have the funds to buy the company interests of a deceased owner at a previously agreed upon price. That way, the owners get the business and the family gets the money. To protect a business in case of the death of a key employee, "key person insurance," payable to the company, provides the owners with the financial flexibility needed to either hire a replacement or work out an alternative arrangement.

You're Single
Most single people don't need life insurance because no one depends on them financially. But there are exceptions. For instance, some single people provide financial support for aging parents or siblings. Others may be carrying significant debt that they wouldn't want to pass on to family members who survive them. If you're in these types of situations, you should own life insurance because you wouldn't want your loved ones to be burdened financially in the event of your premature death.

There are many kinds of life insurance, but they generally fall into two categories: term insurance and permanent insurance.
Term insurance is designed to meet temporary needs. It provides protection for a specific period of time (the "term") and generally pays a benefit only if you die during the term. This type of insurance often makes sense when you have a need for coverage that will disappear at a specific point in time. For instance, you may decide that you only need coverage until your children graduate from college or a particular debt is paid off, such as your mortgage.

In contrast, permanent insurance provides lifelong protection. As long as you pay the premiums, and no loans, withdrawals or surrenders are taken, the full face amount will be paid. Because it is designed to last a lifetime, permanent life insurance accumulates cash value and is priced for you to keep over a long period of time.

It's impossible to say which type of life insurance is better because the kind of coverage that's right for you depends on your unique circumstances and financial goals.

Explore the other parts of this section to learn more about term and permanent insurance and the pros and cons of each. Also, try our interactive decision tree. It walks you through the questions you need to consider to determine the kind of life insurance that's right for you.

But remember, the best way to figure out the amount and type of life insurance that makes sense for your particular situation is to meet with a qualified life insurance professional.

As the name implies, term insurance provides protection for a specific period of time and generally pays a benefit only if you die during the "term." Term periods typically range from one year to 30 years, with 20 years being the most common term.

One of the biggest advantages of term insurance is its lower initial cost in comparison to permanent insurance. Why is it cheaper when initially purchased? Because with term insurance, you're generally just paying for the death benefit, the lump sum payment your beneficiaries will receive if you die during the term of the policy. With most permanent policies, your premiums help fund the death benefit and can accumulate cash value.

Term insurance is often a good choice for people in their family-formation years, especially if they're on a tight budget, because it allows them to buy high levels of coverage when the need for protection is often greatest. Term insurance is also a good option for covering needs that will disappear in time. For instance, if paying for college is a major financial concern but you're pretty sure that you won't need life insurance coverage after the kids graduate, then it might make sense to buy a term policy that'll get you through the college years.

But what happens if you buy a term policy only to realize at the end of the term that you still have a need for life insurance? Well, it's sort of a good news, bad news story. The good news is that many policies will give you the option to renew your policy when you reach the end of the term. The bad news is that you'll probably face much higher costs since age is one of key factors used to determine life insurance premiums. To renew the policy, you also may have to present evidence of insurability (that's insurance jargon meaning, "take another medical exam and answer a new round of questions about your lifestyle, health status and family history"). If you're still a fine specimen with healthy living habits, you might requalify at a reasonable rate. But if your health has deteriorated, you may find that with continually increasing premiums it's too expensive to renew your policy or you may not even requalify.

So if you're considering a term policy, make sure you carefully consider how long you'll need the coverage. If you're pretty sure that your needs are temporary, then term insurance may be an excellent choice. But if you think there's a real possibility that you might need the coverage for a long time, then remember that if you want to renew your term policy after it expires or buy a new term policy at that time, your age, health status or other factors may make coverage very expensive.

To better understand term insurance, consider this analogy. When you purchase term insurance, it's sort of like renting a house. When you rent, you get the full and immediate use of the house and all that goes with it, but only for as long as you continue paying rent. As soon as your lease expires, you must leave. Even if you rented the house for 30 years, you have no "equity" or value that belongs to you.

One exception to this rule is what's called a return-of-premium term policy. With these policies, if you keep the policy in force for the entire term, say 20 years, the insurance company will refund the premium payments you made over that 20-year period. Of course, there is a price to be paid for this added benefit. The premiums for return-of-premium policies are considerably higher than premiums for standard term policies. The price difference can be 30%, 40% or more. Another factor to consider is that term insurance rates have dropped considerably over the past decade, mostly because people are living longer. If you own a standard term policy, there's really no harm done in dropping that policy in favor of a newer and cheaper term policy. But if you own a return-of-premium policy, dropping the policy before the full term has expired means that you will have paid a high price for your term insurance coverage and the premiums you paid won't be refunded.

When considering a term purchase, one thing to keep in mind is that not all term policies are the same. Some may include certain provisions as standard features, while others may require you to pay extra to add these features as "riders" to your policy. So if you're comparing term policies, remember that price is not the only factor to consider. Ask your agent about provisions such as accelerated death benefits, disability waiver of premium, and accidental death benefits.

Another provision that is very important is something called convertibility. This valuable feature is usually available in the first few years of the policy, and allows you to convert your term policy to a permanent policy (e.g., whole life insurance) without submitting evidence of insurability. Being able to convert to a permanent policy is a great option to have in the event that circumstances in your life change such as failing health or maybe just the realization that coverage is needed for a longer period of time than you originally anticipated. That's why when purchasing a term policy, it's never a bad idea to find out what kind of permanent policies are offered by the company you are considering. Some companies may only have strong term insurance offerings, while others may have very competitive products in both categories.

One final piece of advice. Here are some important questions to ask yourself when considering the purchase of a term policy:

• How long can I keep this policy?
• If I want the option to renew the policy for a specific number of years or until a certain age, what are the terms of renewal?
• When will my premiums increase? Annually? Or after a longer period of time, such as five, ten, or twenty years?
• Can I convert to a permanent policy? If so, how many years will this option be available to me and will I need a medical exam if I want to convert?

Permanent insurance provides lifelong protection. As long as you pay the premiums, the death benefit will be paid. These policies are designed and priced for you to keep over a long period of time. So if you don't intend to keep the policy for the long term, this may be the wrong type of insurance for you.

Why would someone need coverage for an extended period of time? Because contrary to what a lot of people think, the need for life insurance often persists long after the kids have graduated college or the mortgage has been paid off. If you died the day after your youngest child graduated from college, your spouse would still be faced with daily living expenses. And what if your spouse outlives you by 10, 20 or even 30 years, which is certainly possible today. Would your financial plan, without life insurance, enable your spouse to maintain the lifestyle you worked so hard to achieve? And would you be able to pass on something to your children or grandchildren?

Another key characteristic of permanent insurance is a feature known as cash value or cash-surrender value. In fact, permanent insurance is often referred to as cash value insurance because these types of policies can build cash value over time, as well as provide a death benefit to your beneficiaries.

Cash values, which accumulate on a tax-deferred basis just like assets in most retirement and tuition savings plans, can be used in the future for any purpose you wish. If you like, you can borrow cash value for a down payment on a home, to help pay for your children's education or to provide income for your retirement. When you borrow money from a permanent insurance policy, you're using the policy's cash value as collateral and the borrowing rates tend to be relatively low. And 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 and cash surrender value.

If you need or want to stop paying premiums, you can use the cash value to continue your current insurance protection for a specified time or to provide a lesser amount of protection covering you for your lifetime. If you decide to stop paying premiums and surrender your policy, the guaranteed policy values are yours. Just know that if you surrender your policy in the early years, there may be little or no cash value.

With all types of permanent policies, the cash value of a policy is different from the policy's face amount. The face amount is the money that will be paid at death or policy maturity (most permanent policies typically "mature" around age 100). Cash value is the amount available if you surrender a policy before its maturity or your death. Moreover, the cash value may be affected by your insurance company's financial results or experience, which can be influenced by mortality rates, expenses, and investment earnings.

Types of Permanent Insurance

"Permanent insurance" is really a catchall phrase for a wide variety of life insurance products that contain the cash-value feature. Within this class of life insurance, there are a multitude of different products. Here we list the most common ones.

If you're the kind of person who likes premiums that will remain fixed and predictable over time, you may want to consider:

Whole life or ordinary life. This the most common type of permanent insurance. It provides you with the certainty of a guaranteed amount of death benefit and a guaranteed rate of return on your cash values. And you'll have a level premium that is guaranteed to never increase for life.

Another valuable benefit of a participating whole life insurance policy is the opportunity to earn dividends. While your policy's guarantees provide you with a minimum death benefit and cash value, dividends give you the opportunity to receive an enhanced death benefit and cash value growth. Dividends are a way for the company to share part of its favorable results with policyholders. When you purchase a participating policy, it is expected that you will receive dividends after the second policy year - but they are not guaranteed. Dividends, if left in the policy, can provide an offset (and more) to the eroding effects of inflation on your coverage amount.

Variable life. This type of insurance is offered via a prospectus and provides death benefits and cash values that vary with the performance of a portfolio of underlying investment options. You can allocate your premiums among a variety of investment options offering different degrees of risk and reward: stocks, bonds, combinations of both, or a fixed account that guarantees interest and principal. This type of insurance is for people who are willing to assume investment risk to try to achieve greater returns. With variable life you're shifting much of the investment risk from the insurance company to yourself. Good investment performance would provide the potential for higher cash values and ultimate death benefits. If the specified investments perform poorly, cash values and death benefits would drop accordingly.

While some people like the predictability of fixed premiums, others prefer adjustable premiums because they like having the option to make higher premium payments when they have extra cash on hand or lower ones when money is tight. If you find this kind of flexibility appealing, you may want to consider:

Universal life. This type of insurance is offered via a prospectus and allows you, after your initial payment, to pay premiums at any time, in virtually any amount, subject to certain minimums and maximums. You also can reduce or increase the death benefit more easily than under a traditional whole life policy. With universal life, you get the certainty of a guaranteed minimum amount of death benefit, as long as premiums are sufficient to sustain that death benefit. Any guarantee relies on the claims paying ability of the issuing insurance company. As such, do your homework and select a financially sound company. Most universal life policies will also provide a guaranteed rate of return on your cash values, with one important exception. It is possible that you will not accumulate any cash value if any, or all, of the following circumstances occur: administrative expenses increase, mortality assumptions are changed, the insurance company's investment portfolio underperforms, premium payments are insufficient.

Variable Universal Life. This type of insurance is similar to universal life. It is a flexible premium, permanent life insurance policy that allows you to have premium dollars allocated to a variety of investment options, including a fixed account. The policy generally provides income tax-free death benefit, has a cash value that grows tax-deferred, and is accessible through policy loans and/or withdrawals. Note that loans and withdrawals will reduce the death benefit by the outstanding loan amount plus any interest. The policy allows for increase or decrease of the policy coverage and premium changes to the life insurance benefit option. Some companies also give you the option to guarantee the death benefit with the Guaranteed Minimum Death Benefit Rider. Overall, variable universal life can be a good option for people who want to combine life insurance with a higher potential for investment return at a higher risk, of course. For more complete information, be sure to always request the appropriate product and fund prospectuses as they contain information you need to consider such as the investment objectives, risks, and charges and expenses of the investment.

One of the most common questions people have about life insurance is, term or permanent? The answer is: it depends - on a number of factors, including how long you need the coverage, how much you can afford, how much risk you can tolerate and how much flexibility you need.

While this interactive guide is not meant to be a substitute for working with an insurance agent, it's a great way to familiarize yourself with some of the issues you'll need to think through in making this important decision.

The key to any good relationship is trust and the client/agent relationship is no exception. You need to trust your agent's knowledge, experience and professional judgment. And above all, you always should feel that the agent is acting in your best interest. The agent also needs to trust you. He or she needs to know that the information you provide is truthful and complete. And ultimately, the agent needs to have faith in your ability to make the right choices for your family.

When the time comes to sit down with your agent, here's some information that will help ensure a productive meeting:

Be ready to answer lots of questions. In order to conduct a thorough financial needs analysis, your agent will need to gather a lot of information on your financial situation and goals. So prior to the meeting, you might want to prepare (or update) your personal financial statement. This is a document that outlines your living expenses as well as your major assets and liabilities. Your agent will use this information to discuss your insurance options and set reasonable financial goals for you and your family.

Expect detailed questions about your health. For example, you can expect questions about your age, medical condition, medical history, family health history, and personal habits, such as any risky hobbies you may have. When you apply for life insurance, you'll typically be asked to have a medical exam. Often, a licensed medical professional will make a personal visit to your home.

Be truthful at all times. Always answer questions about medical history and health carefully and truthfully. This information helps a company establish a premium for your coverage based on your risk. For instance, you may pay a lower premium if you don't smoke. On the other hand, if you have a chronic illness, you may be charged a higher premium. Also, in the event of a claim, accurate and truthful answers enable your beneficiary to receive prompt payment. Inaccurate or untruthful answers, however, may cause delay or even denial of a claim.

Make sure you receive the attention and advice you deserve. You should feel satisfied that your agent is listening to you and doing all that he or she can to find you the right type and amount of insurance at an affordable price. Your agent should take the time to carefully assess your financial situation and explain in detail any recommendations that he or she makes. Never allow yourself to be rushed into a decision and if you don't understand something your agent is trying to explain to you, ask to have it explained again. If you are not comfortable with your agent, or you aren't convinced he or she is providing the service you want, find another agent.

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