10 Financial Planning With Life Insurance Primary Purpose of Life Insurance: Protect someone who depends on you from financial loss related to your death Reduces financial burdens of survivors Life insurance: Obtained by purchasing a policy The insurance company promises to pay a lump sum (death benefit) to a named beneficiary at the time of the policy holder’s death (or sometimes while they are still alive) 10-1

Objective 1 Define Life Insurance and Determine Your Life Insurance Needs Other reasons to buy life insurance: Pay off a mortgage or debts Lump-sum endowments for children Provide an education or income for children Make charitable donations Provide retirement income Accumulate savings Establish a regular income for survivors Set up an estate plan (e.g., fund trusts with life insurance) Pay estate and gift taxes (e.g., business owners) 10-2

The Principle of Life Insurance Mortality Tables-provide odds on your dying, based on your age and sex. Premium is based on life expectancy and projections for payouts for persons who die (called actuarial tables) Older people pay more because they will die sooner Face Amount- the dollar value of protection listed in the policy and amount used to calculate the premium (e.g., $100,000) Group Term Insurance- issued to people as members of a group rather than as individuals 10-3

Do You Need Life Insurance? Do you have people you need to protect financially? Will your death cause them financial hardship? Are you single and have a lot of debt? Do you have parents, relatives, or a charity that you want to support? Avoid being persuaded to buy unnecessary life insurance! 10-4

Estimating Your Life Insurance Requirements The Easy Method 70% of your salary for seven years while your family adjusts Assumes typical family The DINK Method Dual income, no kids Assumes spouse earnings will continue Cover funeral + ½ debts The “Nonworking” Spouse Method # years until the youngest child reaches 18 X $10,000 The “Family Need” Method More thorough than the first three methods Considers employer provided insurance, Social Security benefits, income and assets 10-5

2 Types of Life Insurance Companies Objective 2 Distinguish Between the Types of Life Insurance Companies and Analyze Various Types of Life Insurance Policies These Companies Issue 2 Types of Life Insurance Companies Type of Company Owned by Stock life Insurance Shareholders Mutual life insurance Policyholders 10-6

Stock Life Insurance Companies Owned by the shareholders 95% are of this type Sell non-participating (non-par) policies If you want to pay the same premium each year  choose a non-participating policy with guaranteed premiums Consider the financial stability of the insurance company 10-7

Mutual Life Insurance Companies Owned by the policyholders 5% of policies are from this type of company Participating policy premiums are higher than non-participating policies Part of the participating premium is refunded to the policyholders annually in the form of a policy dividend 10-8

Term Life Insurance Term Life Many types: Protection for a specified period of time At the end of term (or if you stop paying premiums), coverage stops Many types: Renewable Term- can renew; higher premium charged Multiyear Level Term- same premium for set period Conversion Term- allows change to permanent policy Decreasing Term- face value decreases over time Return-of-Premium Term- can get premium back 10-9

Whole Life Insurance Straight-Life or Whole-Life Insurance Pay the premium as long as you live Amount of premium depends on age when you start the policy Provides death benefits Accumulates a cash value you can borrow against or draw out at retirement Look carefully at the rate of return your money earns Types: Limited Payment Policy You pay premiums for a stipulated period Policy then “paid up” and you remain insured for life Variable Life Policy- Fixed premiums; investment accounts Adjustable Life Policy- Can change coverage with needs Universal Life- Can change premium, time period, benefit 10-10

Comparison of Premium Dollars for Life Insurance

Other Types of Life Insurance Policies Group life insurance Term insurance Often provided by an employer No physical is required Credit life insurance Debt paid off if you die Mortgage, car, furniture Also protects lenders Expensive protection (usually overpriced) Endowment Life Insurance- pays policyholder a lump sum if still living at end of the endowment period 10-12

Key Provisions in a Life Insurance Policy Naming your beneficiary and contingent beneficiaries (those who will receive benefits upon the insured’s death) Incontestability clause  after the policy has been in force for a specified period, the company can’t dispute its validity for any reason (usually 2 years) Length of grace period for late payments Reinstatement of a lapsed policy if it has not been turned in for cash (must qualify again and pay overdue premiums) Non-forfeiture clause allows you to keep accrued benefits in a whole life policy if you drop the policy Misstatement of age provision (benefits paid on real age) Policy loan provision to borrow against cash value Suicide clause during first two years (only get back premiums) Policy rider modifies the coverage by adding or excluding conditions or altering benefits 10-13

Key Provisions in a Life Insurance Policy Life Insurance Policy Riders Waiver of premium disability benefit Accidental death benefit – “double indemnity” Guaranteed insurability option (can buy additional insurance at specified intervals without a medical exam) Cost of living protection (helps maintain purchasing power) Accelerated benefits, also called living benefits (make payments to those who are terminally ill before they die) Second-to-die option, also called survivorship life (insures two lives, typically a married couple); benefit paid upon death of second spouse 10-14

Choosing Settlement Options Settlement Options = choices of how the insurance money is paid out Lump-Sum Payment = most common method Limited Installment Plan In equal installments for a specific number of years after your death (10-year certain) Life Income Option Payments to the beneficiary for life Proceeds Left with the Company Pays interest to the beneficiary 10-15

Buying Life Insurance Consider: Present and future sources of income Other savings and income protection Group life insurance Pension benefits Social Security benefits Financial strength of the insurance company 10-16

Buying Life Insurance Determine from whom to buy your policy Examine both private and public sources Research the company’s rating by major rating companies: A. M. Best Standard and Poor’s Duff & Phelps Moody’s Weiss Research Talk to friends or colleagues Online premium quote services 10-17

Choosing an Insurance Agent Ask friends, parents, and neighbors for recommendations. Does the agent belong to professional groups or is a Chartered Life Underwriter (CLU)? Is the agent willing to take the time to answer questions and find a policy that is right for you? Does the agent ask about your financial plan? Do you feel pressured? Is the agent available when needed? 10-18

Buying Life Insurance Compare policy costs based on: Company’s cost of doing business Return on company’s investments Mortality rate among policyholders Policy features Competition from other firms Interest-adjusted index Used to compare policy costs Lower index = lower cost policy See sites such as www.quotesmith.com 10-19

Obtaining and Examining a Policy First step = apply Second step = provide medical history Usually no physical for a group policy Read every word of the contract 10-day “free-look” period to change your mind Give your beneficiaries and lawyer a photocopy 10-20

Should You Switch Policies? Switch if benefits exceed costs of getting another physical and paying policy set-up costs The older you are, the higher the premium Are you still insurable? Can you get all the provisions you want? Don’t cancel old policy until new policy is in hand 10-21

Objective 4 Recognize How Annuities Provide Financial Security Financial Planning with Annuities An annuity = a financial contract written by an insurance company, providing a regular income Can supplement retirement income and shelter income from taxes (tax-deferred) Those who expect to live longer than average benefit most from annuities Fully fund IRAs and 401(k)s/403(b)s BEFORE considering an annuity (lower costs and tax advantages) 10-22

Why Buy Annuities? Provides retirement income for life Compounded interest grows tax-free (until money withdrawn) No maximum annual contribution (like IRAs) Beneficiary guaranteed no less than amount paid in Immediate annuity or deferred annuity Two Types Fixed Annuity Annuitant receives fixed amount for life Variable Annuity Amount received depends on investment performance 10-23

Wrap Up Chapter Quiz Case Study Project Discussion Form groups Select cases Homework: Concept Checks 10-1, 10-2 (True/False Questions)