Avoid Life Insurance Pitfalls

Most individuals have some form of insurance, whether it is for their vehicle, home or health. It is important, however, not to overlook the benefits of life insurance, which is a policy that pays money to beneficiaries when the person who is insured by the plan dies.

Typically, the insured person makes payments into the plan - called premiums - in exchange for a "death benefit," the money that is paid at the time of death. Regardless of whether you are considering purchasing life insurance or you have been a policyholder for years, there are a few potential problems you may need to be aware of and perhaps work through.

There are numerous types of policies you can choose from when it comes to purchasing life insurance, but it can be challenging to figure out which one is the best fit for you. Life insurance policies generally fall into three categories based on your needs - protection, long-term savings and estate conservation.

Many people purchase life insurance for the purpose of providing for your dependents in the event of your death, thus protecting your existing stream of income for them after you die. If you are in the protection category you may want to consider term life insurance, which offers only a death benefit for a specified period of time such as 10 or 20 years. In addition, you can typically purchase substantial coverage at affordable premiums due to the limited time of protection.

If long-term savings is your goal for purchasing insurance, you may consider a cash-value policy. With this type of life insurance, your beneficiaries receive a payment upon your death based on the cash value of the plan, which builds over the years. The value of these plans is usually tied to an underlying investment portfolio and that's how funds accumulate. Another added benefit is that these policies usually allow a holder to borrow from the accumulated funds in the plan without taxes or penalties. Depending on the policy, you can typically withdraw a portion of the cash value and not pay it back, or even cancel the policy and receive the money that has accumulated over the years.

Life insurance can also be used as an estate-planning tool, especially if your goal is to preserve wealth for future generations. A common choice to achieve this objective is survivorship life insurance. This type of policy covers two lives, and beneficiaries are paid when the second person dies. The cash generated by these plans typically helps your heirs pay estate taxes.

Now that you know some of your life insurance options, you have to decide how much coverage to purchase. A key thing to consider when making this decision is the amount of income your family will need in the event of your death. After all, your goal in purchasing life insurance most likely is to ensure that your paycheck continues for those who are dependent upon your income or to pass some of your wealth to your heirs. Many experts think families need about 75 percent of their current income should something happen to the primary breadwinner.

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It is also important not to ignore the need for life insurance protection in a dual income family. The death of either spouse could create a financial strain on your family. Households with one stay-at-home parent should also consider coverage, as the survivor could have trouble paying child care expenses after the death of the nonworking spouse.

After you have determined what type and how much life insurance to purchase, you must decide who will receive the money from the policy in the event of your death. children may be an obvious choice as a beneficiary, but be careful of giving cash to a minor, as they could spend it on anything they choose. A trust or other type of savings plan may be a better choice to benefit your children if they are young. In addition, you should name at least one secondary beneficiary in case something happens to the primary.

Life insurance can be a complex, but necessary, part of a healthy financial plan. If there are individuals who depend on you, it is important to protect them with a policy that fits with your needs as well. Talk with your financial consultant about what type of life insurance might be a good fit for your financial future.