When we buy insurance, we often feel that we are doing the best we can to protect our family and ourselves financially. And indeed, in many ways life insurance can be a great way to protect your loved ones from financial loss in the event of your unexpected demise. The problem is, however, that we do not always understand fully all of the implications of buying insurance and may accidentally be setting ourselves up for financial disaster. So how does one go about avoiding this common but potentially devastating mistake?
Cash value life insurance, also known as insured cash value, is basically a form of insurance whose underlying asset is your cash savings. Cash value life insurance usually s is a type of permanent life insurance with a kind of savings account tied into it, so you’re paying for two things here: the life insurance component (which covers your dependents if you die) and the actual cash value component (which can grow your money through tax-deferred growth). Because of this, cash value policies pay out a set amount of premiums each month that is invested in a variety of options.
These policies offer a great deal of flexibility. However, before you consider any type of investment, you need to first work out exactly how much risk you are exposed to on a regular basis. As any financial advisor will tell you, calculating risk is a key part of any meaningful investing strategy. The easiest way to work this out is to work out how much you currently owe and then subtract your expected future payments from this figure.
The next thing you need to think about is how much you are going to take out each month. Although the death benefit amount is the most significant part of any life insurance policy, it should not be the only consideration. In fact, many financial products today include a term life policy as a complementary product to a full investment fund. So work out how much you are likely to take out each month and then look at the different options available to you.
When you have determined the extent of risk you are exposed to, you can then consider whether a permanent life insurance product makes sense for you. As you may be aware, there are two main types of permanent life insurance policies – those that tax you on the death benefit and those that do not. The one that does not tax you is called tax-free. Tax-free policies pay out no income tax on the death benefits. It does make sense to take out the higher level of insurance as the cash value grows and it is more tax-effective as you have already paid income tax on the premiums.
But there is also another option available to you. It’s called decreasing your cash value. What you do with your cash value is called decreasing your premium. So when you are paying the same cash value on a whole life insurance premium, but you can choose to decrease your premium, you are effectively reducing the amount of your death benefit. This means that you will pay less money as your death benefit, but you might find that the cost of insurance is still the same as it was before. So in essence, decreasing your premium means that you are choosing between life insurance premiums and death benefits.
Some universal plans also allow you to decrease your premiums. In general, though, these tend to be relatively expensive because of the additional tax-free component. You can find some variable universal life insurance company that offer premium reductions that may equal up to 70% of the total cost of the plan. So you do not always need to take the full amount of the premiums and this makes it less risky for the insurance company if you decide to stop paying your premiums.
In general the best way to determine the amount of the face amount is to look at your life insurance features and compare the face amount with the face amount plus one. The face amount is what the insurance company pays for the death benefit; the face amount plus one is what the insurance company pays for the benefit if the insured person dies during the term of the plan. If you have adequate coverage on your policy, you don’t need to take out as much face amount as you probably don’t need to. If you are not adequately covered then you can drop some of the face amount without increasing your premium payments.
