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Financial Planning with Life Insurance

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1 Financial Planning with Life Insurance
Chapter 10 Financial Planning with Life Insurance McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

2 Life Insurance Chapter Learning Objectives
LO10.1 Define life insurance and determine your life insurance needs. LO10.2 Distinguish between the types of life insurance companies and analyze various types of life insurance policies these companies issue. LO10.3 Select important provisions in life insurance contracts and create a plan to buy life insurance. LO10.4 Recognize how annuities provide financial security.

3 Learning Objective LO10.1 Define Life Insurance and Determine Your Life Insurance Needs
Primary Purpose of Life Insurance: Protect someone who depends on you from financial loss related to your death Life insurance: Obtained by purchasing a policy The insurance company promises to pay a lump sum to a named beneficiary at the time of the policy holder’s death (or sometimes while they are still alive)

4 Purpose of Life Insurance
Other reasons: 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 Pay estate and gift taxes

5 The Principle of Life Insurance
Mortality tables provide odds on your dying, based on your age and sex. Premium is based on your life expectancy and the projections for the payouts for persons who die

6 Do You Need Life Insurance?
Do you have people you need to protect financially? Are you single and have a lot of debt? Do you have parents, relatives, or a charity that you want to support?

7 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 => insured Cover funeral + ½ debts

8 Estimating Your Life Insurance Requirements
The “Nonworking” Spouse Method # years until the youngest child reaches 18 X $10,000 The “Family Need” Method More thorough than the first three Considers employer provided insurance, Social Security benefits, income and assets

9 2 Types of Life Insurance Companies
Learning Objective LO10.2 Types of Life Insurance Companies and Policies 2 Types of Life Insurance Companies Type of Company Owned by Policy Type Stock life Insurance Shareholders Nonparticipating Mutual life insurance Policyholders Participating

10 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

11 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 non-participating premium is refunded to the policyholders annually in the form of a policy dividend

12 Types of Life Insurance Policies
Term life insurance Whole Life insurance Group Life insurance Credit life insurance Endowment Life insurance

13 Term Life Insurance “Term Life” Many types:
Protection for a specified period of time If you stop paying premiums, coverage stops Many types: Renewable term – Price on renew Multiyear level term – straight term, Price fixed Conversion term – convertible to other types of life insurance Decreasing term – Coverage over time Return-of-premium term – you get your money back (if you live)

14 Whole Life Insurance “Straight Life”
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 the cash value or draw it out at retirement Look carefully at the rate of return your money earns

15 Whole Life Policy Options
Limited Payment Policy You pay premiums for a stipulated period Usually 20 or 30 years, or Until you reach a specified age (65) Policy then “paid up” and you remain insured for life Variable Life Policy Minimum death benefit guaranteed Benefit can be greater depending on earnings of the dollars invested in the separate fund

16 Whole Life Policy Options
Adjustable Life Policy Can change premium payments or period of coverage as your needs change. Universal Life Term life policy with a cash value Can borrow against cash value Premium amount may be changed at any time without changing coverage Part of premium goes to investment account Increase in cash value reflects interest earned on short-term investments

17 Other Types of Life Insurance Policies
Group life insurance Term insurance Often provided by an employer No physical required Credit life insurance Debt paid off if you die Mortgage, car, furniture Also protects lenders Expensive protection Endowment Life Insurance Pays you if you live, otherwise pays beneficiary

18 Comparison of Major Types of Life Insurance

19 Key Provisions in a Life Insurance Policy
Naming your beneficiary and contingent beneficiaries Incontestability clause  after the policy has been in force for a specified period, the company can’t dispute its validity for any reason Length of grace period for late payments Reinstatement of a lapsed policy if it has not been turned in for cash

20 Key Provisions in a Life Insurance Policy
Non-forfeiture clause allows you to keep accrued benefits in a whole life policy if you drop the policy Misstatement of age provision Policy loan provision to borrow against cash value Suicide clause during first two years Policy rider modifies the coverage by adding or excluding conditions or altering benefits

21 Key Provisions in a Life Insurance Policy
Life Insurance Policy Riders Waiver of premium disability benefit Accidental death benefit - double indemnity Guaranteed insurability option Cost-of-living protection Accelerated benefits, also called living benefits, pay to those who are terminally ill before they die Second-to-die option, also called survivorship life, insures two lives

22 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

23 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

24 Choosing Your Insurance Agent
Ask friends, parents, and neighbors for recommendations Is the agent available when needed? Does the agent advise you to have a financial plan? Do you feel pressured? Does the agent keep current with changes in the insurance field? Does the agent belong to professional groups or is a Chartered Life Underwriter (CLU) who require continuing education? Is the agent willing to take the time to answer your questions and find a policy that is right for you?

25 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 and

26 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

27 Choosing Settlement Options
Settlement Options = choices of how the insurance money is paid out Lump-sum payment = most common 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

28 10 Golden Rules of Buying Life Insurance
From Page 338, Personal Finance in Practice Box Source: American Council of Life Insurance

29 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?

30 Learning Objective LO10.4 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 Those who expect to live longer than average benefit most from annuities Fully fund IRAs, Keoghs and 401(k)’s BEFORE considering an annuity

31 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

32 Types of Annuities Immediate annuity Deferred annuity Fixed annuity
Income payments begin at once Deferred annuity Payments begin at some point in the future Fixed annuity Annuitant receives fixed amount for life Variable annuity Amount received depends on investment performance Can be included in IRAs and Keogh plans

33 Costs of Annuities Surrender charges Mortality and expense risk charge
Charged if you withdraw money within a certain period Mortality and expense risk charge Usually 1.25% of account value per year Administrative fees Flat fee $25-$30 per year Percentage – usually 0.15% per year Fund expenses

34 Tax Considerations of Annuities
Tax Reform Act of 1986 Preserves tax advantage of annuities and insurance No maximum contribution Beneficiary guaranteed no less than contributed

35 Chapter Summary Learning Objective LO10.1
Life insurance protects the people who depend on you from financial losses caused by your death. Estimation methods: DINK method “Nonworking” spouse method “Family need” method

36 Chapter Summary Learning Objective LO10.2
Two types of insurance companies: Stock insurance companies Mutual insurance companies Types of policies: Nonparticipating Participating Two basic types of insurance: Term life Whole life Many variations and combinations

37 Chapter Summary Learning Objective LO10.3
Most life insurance policies have standard features. An insurance company can change the conditions of a policy by adding a rider to it. Before buying life insurance, consider all your present and future sources of income, then compare the costs and choose appropriate settlement options.

38 Chapter Summary Learning Objective LO10.4
An annuity pays while you live, whereas life insurance pays when you die. With a fixed annuity, you receive a fixed amount of income over a certain period or for life. With a variable annuity, the monthly payments vary because they are based on the income received from stocks or other investments.

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