Life insurance can provide cash to your named beneficiaries after you pass away. This cash can help your family replace your income, cover your final expenses1 or cover major ongoing expenses from mortgage payments to college tuition. You may also want to use life insurance to leave a legacy to your favorite charity, religious organization, or other institution. Life insurance benefits are generally free from federal income taxes.
There are two basic types of life insurance policies:
Permanent, or cash value, insurance remains in effect for your entire life. This type of insurance builds cash value over time, which is an asset that you can use.
- You can take a loan against the policy and use the cash for any purpose. The receipt of the cash is typically not a taxable event. If you die while there is a loan outstanding, the insurance proceeds payable to your beneficiary are typically reduced by the value of the loan. Be sure to fully understand the terms of the loan, the interest rate, and repayment options.
- If you stop paying the premiums, the cash value may be usable to fund the premium payments or provide a lower death benefit.
- You can cash in, or surrender, the policy and receive the cash value amount. When you surrender the policy, the policy is no longer in effect, and a death benefit will not be paid. The disbursement of the cash value is taxable to you.
- You may be able to customize the coverage to include a disability benefit rider or an extended care rider designed to help pay for long term care costs.
Term insurance is purchased for a specific time period and is usually less expensive than permanent insurance. For example, you may want life insurance to cover your family until your children are out of college or until your mortgage is paid off. Thus, you would purchase a policy for the time period required, such as 20 or 30 years, and the dollar value you need to cover the expense.
Premiums are usually determined based on the type of insurance, the amount of coverage, your age, and, for larger policies, your health.
1 In 2020, average funeral expenses amount to $7,500, according to AARP.