Questions

Get your answers here.

  1. How can I insure against loss of income?
  2. What are the types of disability insurance?
  3. How can I purchase disability insurance?
  4. How are disability premiums determined?
  5. How can I save money?
  6. What is 'long-term care'?
  7. Will I need long-term care?
  8. Should I buy long-term care insurance?
  9. How much does long-term care cost?
  10. What’s the best age to buy long-term care insurance?
  11. What kinds of health insurance are there?
  12. How do I pick a health plan?
  13. If I change jobs or become unemployed, can I bring my coverage with me?
  14. Why should I buy life insurance
  15. How much life insurance do I need?
  16. What are the principal types of life insurance?
  17. What are the types of term insurance policies?
  18. What are the different types of permanent policies?
  19. What is an annuity?
  20. Why should I consider purchasing an annuity?
  21. How much should I invest in an annuity?
  22. How will I receive my annuity payments?

Answers

  1. How can I insure against loss of income?

    Answer: If you were disabled and unable to work as a result of an accident or illness, what would you and your family do for income?

    Disability income insurance, which complements health insurance, can replace lost income. Forty-three percent of all people age 40 will have a long-term (lasting 90 days or more) disability event by age 65.

    There are three basic ways to replace income:

    1. Employer-paid disability insurance

      This is required in most states. Most employers provide some short-term sick leave. Many larger employers provide long-term disability coverage as well, typically with benefits of up to 60 percent of salary lasting from five years to age 65, and in some cases extended for life.

    2. Social Security disability benefits

      This can be paid to workers whose disability is expected to last at least 12 months and is so severe that no gainful employment can be performed.

    3. Individual disability income insurance policies

      Other limited replacement income is available for workers under some circumstances from workers compensation (if the injury or illness is job-related), auto insurance (if disability results from an auto accident) and the Department of Veterans Affairs.

    For most workers, even those with some employer-paid coverage, an individual disability income policy is the best way to ensure adequate income in the event of disability. When you buy a private disability income policy, you can expect to replace from 50% to 70% of income. Insurers won’t replace all your income because they want you to have an incentive to return to work. However, when you pay the premiums yourself, disability benefits are not taxed. (Benefits from employer-paid policies are subject to income tax.) Top of Page

  2. What are the types of disability insurance?

    Answer: There are two types of disability policies: Short-Term Disability (STD) and Long-Term Disability (LTD):

    1. Short-Term Disability policies (STD) have a waiting period of 0 to 14 days with a maximum benefit period of no longer than two years.
    2. Long-Term Disability policies (LTD) have a waiting period of several weeks to several months with a maximum benefit period ranging from a few years to the rest of your life.

    Disability policies have two different protection features that are important to understand.

    1. Noncancelable means the policy cannot be canceled by the insurance company, except for nonpayment of premiums. This gives you the right to renew the policy every year without an increase in the premium or a reduction in benefits.
    2. Guaranteed renewable gives you the right to renew the policy with the same benefits and not have the policy canceled by the company. However, your insurer has the right to increase your premiums as long as it does so for all other policyholders in the same rating class as you.

    In addition to the traditional disability policies, there are several options you should consider when purchasing a policy:

    • Additional purchase options

      Your insurance company gives you the right to buy additional insurance at a later time.

    • Coordination of benefits

      The amount of benefits you receive from your insurance company is dependent on other benefits you receive because of your disability. Your policy specifies a target amount you will receive from all the policies combined, so this policy will make up the difference not paid by other policies.

    • Cost of living adjustment (COLA)

      The COLA increases your disability benefits over time based on the increased cost of living measured by the Consumer Price Index. You will pay a higher premium if you select the COLA.

    • Residual or partial disability rider

      This provision allows you to return to work part-time, collect part of your salary and receive a partial disability payment if you are still partially disabled.

    • Return of premium

      This provision requires the insurance company to refund part of your premium if no claims are made for a specific period of time declared in the policy.

    • Waiver of premium provision

      This clause means that you do not have to pay premiums on the policy after you’re disabled for 90 days. Top of Page

  3. How can I purchase disability insurance?

    Answer: Talk to the agent who sells you your life, health, auto or business insurance—he or she may either sell disability coverage or will be able to refer you to an agent who does.

    Your state's insurance department will also have names of agents and companies writing policies in your state.

    Make sure that you understand what you are buying and don’t be afraid to ask your agent to explain exactly what is in the policy.

    Key things to look for when you shop around

    1. The definition of disability

      2. Some policies pay benefits if you are unable to perform the customary duties of your own occupation. Others pay only if you are unable to perform any job suitable for your education and experience. Some policies define disability in terms of your own occupation for an initial period of two or three years and then continue to pay benefits only if you are unable to perform any occupation. "Own occupation" policies are more desirable, but more expensive.

    2. Benefit period

      3. The benefit period is the amount of time you will receive monthly benefits during your life. Experts usually recommend that the policy you buy pay you benefits until at least age 65, at which point Social Security disability will take over. If you are young, you may consider buying a policy offering lifetime benefits because it will still be relatively inexpensive.

    3. A policy that will replace from 60 percent to 70 percent of your total taxable earnings

      4. A higher replacement percentage, if available, is more expensive. Evaluate your other sources of income before deciding how much disability coverage you need.

    4. Coverage for disability resulting from either accidental injury or illness

      5. An accident-only policy is less expensive but does not provide adequate protection. Ideally, both accident and illness coverage should be purchased.

    5. A cost-of-living increase in benefits

      6. You are buying a policy today that may not pay benefits for a decade or more. Should you need those benefits, you will want them to have kept pace with increases in the cost of living. (Some companies also offer "indexed" benefits, keeping pace with inflation after benefit payments begin.)

    6. A policy paying "residual" or partial benefits

      7. This type of policy is available so that you can work part-time and still receive a benefit making up for lost income. A standard feature in some policies, and added by a rider to others, a residual benefits policy pays partial benefits based on loss of income without an initial period of total disability.

    7. Transition benefits

      8. Offered by some companies, it can offset financial loss during a post-disability period of rebuilding a business or professional practice.

    8. Ongoing coverage

      9. A non-cancelable policy which will continue in force as long as the premiums are paid; neither the benefit nor the premium can change. A guaranteed renewable policy keeps the same benefits but may cost more over time since the insurer can increase the premium if it is increased for an entire class of policyholders.

    9. Financial stability

      10. Check the financial ratings of an insurer. Your insurance agent or company representative should provide this information or check with the following companies, which rate insurance company strength:

    10. Waiting period

      11. Every disability policy imposes a waiting period, also known as the elimination period. This is the number of days you must be disabled before receiving benefits. If you are disabled during the elimination period, you will not receive any benefits, even though you are not able to work. If the elimination period is short, such as 30 or 60 days, the premium will be higher. A longer elimination period may strain your finances more when you need it, but you will be charged a lower premium. Most experts recommend that you select an elimination period of 60 to 90 days. The first check is usually paid 30 days after the waiting period. Top of Page

  4. How are disability premiums determined?

    Answer: Disability premiums are based on your age, sex, occupation and the amount of potential lost income you are trying to protect. In general, the lower the chance that your occupation puts you in harm’s way, the lower the premium. The higher the chance of injury, the bigger the premium. So, for instance, an accountant working in an office would have much lower disability premiums than a construction worker. Top of Page

  5. How can I save money?

    Answer: There are two ways to keep the cost of disability insurance down:

    1. Electing a longer waiting period before benefits begin

      2. If you have enough resources to cover expenses during the first three months of disability, your premiums will be lower than with coverage that starts after 30 days.

    2. Electing a shorter benefit period

      3. In this case, benefits are payable to age 65—the age at which you would normally retire—instead of for a lifetime. However, choosing a benefit period of two-to-five years, ending before normal retirement age, could be penny-wise and pound-foolish. You might save money on premiums, but you could be without coverage when you need it most. Disability of long duration poses the greatest financial hardship. Top of Page

  6. What is 'long-term care'?

    Answer: Because of old age, mental or physical illness, or injury, some people find themselves in need of help with eating, bathing, dressing, toileting or continence, and/or transferring (e.g., getting out of a chair or out of bed). These six actions are called Activities of Daily Living–sometimes referred to as ADLs. In general, if you can’t do two or more of these activities, or if you have a cognitive impairment, you are said to need “long-term care.”

    Long-term care isn’t a very helpful name for this type of situation because, for one thing, it might not last for a long time. Some people who need ADL services might need them only for a few months or less.

    Many people think that long-term care is provided exclusively in a nursing home. It can be, but it can also be provided in an adult day care center, an assisted living facility, or at home.

    Assistance with ADLs, called “custodial care,” may be provided in the same place as (and therefore is sometimes confused with) “skilled care.” Skilled care means medical, nursing, or rehabilitative services, including help taking medicine, undergoing testing (e.g. blood pressure), or other similar services. This distinction is important because Medicare and most private health insurance pays only for skilled care–not custodial care. Top of Page

  7. Will I need long-term care?

    Answer: If you’re under 55, it’s unlikely. Even over 55, only a small percentage of the population will need long-term care before they are in their 70s or 80s.

    However, according to research published in the journal Inquiry by Kemper, Komisar, and Alecxih, most people who turn 65 in 2005 will, in their lifetime, need some level of long-term care.

    Long Term Care Needs
      1 2 3 4 5 6
    LTC Need None Some 1 year or less 1-2 years 2-5 years More than 5 years
    Men 42% 58% 19% 10% 17% 11%
    Women 21% 79% 16% 13% 22% 28%

    Columns 3 through 6 show the distribution of people in column 2. Note that this study defines LTC need as having one or more ADL limitations, four IADL limitations, or using formal LTC services other than post-acute care under Medicare. As such, it indicates somewhat greater usage of LTC services than most long-term care insurance policies would pay for.

    Recent trends suggest that 50 percent or more of the people who might have gone into a nursing home for long-term care will in the future go into an assisted living facility. Assisted living facilities generally cost less than nursing homes. For example, in mid-2005, a MetLife Mature Market Institute survey found a national average daily cost of assisted living facilities of $100, with a range from $55 to $155 across the U.S.

    The good news is that people are living healthier longer—that, in other words, the need for long-term care is diminishing and, when it occurs, the onset of need for long-term care is, on average, occurring later and later in life and starting closer to death (so that future periods of long-term care needs may be shorter than at present). In part, this is due to the adoption of better prevention strategies and better medical practices. Even so, if you do need long-term care services, they can be expensive. Top of Page

  8. Should I buy long-term care insurance?

    Answer: If you need long-term care services and have to pay to obtain them, what financial resources could you call on? Do you have enough to pay for four or more years in a nursing home, an assisted living facility, or home health care?

    If you’re over 65, don’t rely on Medicare or private health insurance. Medicare doesn’t pay for custodial care, and private health insurance rarely pays any of the cost of long-term care.

    If you expect to have very little money when you need long-term care services, you might qualify for Medicaid, a government program that pays the medical and long-term care expenses of poor people. If you expect to be in that situation, you probably shouldn’t buy long-term care insurance, because your state’s Medicaid program will pay your long-term care expenses. Buying long-term care insurance would only save the state—not you—money. The exception is if you live in a state that has a Partnership for Long-Term Care program. Check with your state Insurance Commissioner to determine if you live in a state with a partnership progrm. For residents of these states, buying long-term care insurance does offer an additional benefit.

    If you expect to have a lot of money when you need long-term care services, you also probably shouldn’t buy long-term care insurance. Instead, you should plan to pay for the care “out of pocket”—that is, as a regular expense. One financial advisor suggested in a newspaper interview that if your net worth is in the $1.5 million range, not including the value of your home, you could safely skip buying long-term care insurance and treat long-term care expenses, if they arise, as you do your other bills.

    If you fall in-between these two categories, owning long-term care insurance, like all other insurance coverages, offers peace-of-mind benefits as well as financial ones. For example, a recent survey of people age 50 and over asked how confident they were that they could pay for long-term care services if they needed them. Among those with long-term care policies, 52 percent said they were very confident and another 40 percent said they were somewhat confident. Among those who didn’t own a long-term care policy, only 8 percent were very confident and only 27 percent were somewhat confident.

    But if you’re under 85—and especially if you’re under 65—that doesn’t mean you should ignore the topic of long-term care insurance because

    • You might already be unable to buy long-term care insurance. Wakely Consulting Group, an actuarial firm, studied applicants for long-term care insurance in 2003-2004; the findings: 11 percent of applicants in their 50s, 19 percent in their 60s and 43 percent in their 70s were rejected.
    • A Milliman & Robertson actuary estimated that 15 to 25 percent of the over-65 age group are uninsurable for long-term care.
    • A report from the Henry J. Kaiser Foundation indicates that over five million people ages 18-64 need some type of long-term care.
    • The latest data from the National Center for Health Statistics (for 1999) reported that roughly 160,000 of the people living in nursing homes were under age 65 (nearly 10 percent of the total). Of those receiving home health care services, roughly 400,000 were under 65 (about 30 percent of the total).

    So, unless you have so little money that you will qualify for Medicaid, or so much money that you can pay the bills out of your own pocket, you should consider buying long-term care insurance. Top of Page

  9. How much does long-term care cost?

    Answer: The fact that you might need long-term care doesn’t mean that you have to pay someone to provide it. Many people who need help get it for free from a relative or friend, usually at home. In a recent survey of people over 50, roughly 90 percent said they expect to be the primary caregiver if their spouse or partner needs long-term care.

    But even unpaid caregivers need a break from time to time, or have full- or part-time jobs that prevent them from caregiving throughout the day. If you do pay someone to provide assistance with ADLs, the cost of long-term care depends on three factors – the general level of charges in your part of the country, the specific expense rate for the services you need, and how long the need for care lasts.

    In August 2005, the average cost for a month in a semiprivate room in a nursing home ranged from a low of $3,000 in Shreveport, LA, to a high of $9,250 in New York City, according to a survey by the MetLife Mature Market Institute (MMI). A year-long stay translates to $36,850 in Shreveport and $112,400 in New York City.

    The MMI also surveyed covered costs of Assisted Living and Home Health Care. In August 2005, the lowest average monthly base rate for an Assisted Living facility was $1,650 in Jackson, MS area and the highest was $4,300 in the Stamford, CT. area.

    In August 2005, the lowest average hourly rate for a home health aide was $12 in Shreveport, and the highest was $23 in Rochester, MN. If you need a home health aide around-the-clock, these rates translate to a daily rate ranging from $288 to $552, or a monthly rate of $8,640 to $16,550.

    Finally, don’t forget that long-term care costs, like most health care costs, are rising faster than the general rate of inflation. The bottom line? A four-year-or-longer stay in a nursing home could cost $200,000 to $450,000 or more (in today’s dollars). If you can’t pay this out of your own pocket and aren’t poor enough to qualify for Medicaid, you should consider buying long-term care insurance. Top of Page

  10. What’s the best age to buy long-term care insurance?

    Answer: In general, it's a good idea to buy long-term care insurance before you’re 60, for two reasons:

    1. The younger you are, the less likely it is that you’ll be rejected when you apply for the policy. If you apply in your 50s, there’s a one in ten chance you’ll be rejected. If you apply in your 60s, the chance of rejection is two in ten. If you apply in your 70s, the chance of rejection is four in ten.
    2. The younger you are, the lower the premium will be for a given set of benefits and features. Once the premium is set, it stays at that amount for the life of the policy, unless the claims for the group of people who have bought that type of policy require that rates for the group be raised. Top of Page

  11. What kinds of health insurance are there?

    Answer: There are essentially two kinds of heath insurance: Fee-for-Service and Managed Care. Although these plans differ, they both cover an array of medical, surgical and hospital expenses. Most cover prescription drugs and some also offer dental coverage.

    1. Fee-for-Service

      2. These plans generally assume that the medical professional will be paid a fee for each service provided to the patient. Patients are seen by a doctor of their choice and the claim is filed by either the medical provider or the patient.

    2. Managed Care

      3. More than half of all Americans have some kind of managed-care plan. Various plans work differently and can include: health maintenance organizations (HM0s), preferred provider organizations (PPOs) and point-of-service (POS) plans. These plans provide comprehensive health services to their members and offer financial incentives to patients who use the providers in the plan. Top of Page

  12. How do I pick a health plan?

    Answer: If your employer gives you a choice of plans or you need to purchase your own coverage, it is crucial that you understand your health insurance choices and pick the insurance that is best for you and your family.

    Here are some questions you should ask yourself when choosing a health insurance plan:

    1. How affordable is the cost of care?
      • What is the monthly premium I will have to pay?
      • Should I try to insure most of my medical expenses or just the large ones?
      • What deductibles will I have to pay out-of-pocket before insurance starts to reimburse me?
      • After I’ve met my deductible, what percentage of my medical expenses are reimbursed?
      • How much less am I reimbursed if I use doctors outside the insurance company’s network?
    2. Does the insurance plan cover the services I am likely to use?
      • Are the doctors, hospitals, laboratories and other medical providers that I use in the insurance company’s network?
      • If I want to use a doctor outside the network, will the plan permit it?
      • How easily can I change primary-care physicians if I want to?
      • Do I need to get permission before I see a medical specialist?
      • What are the procedures for getting care and being reimbursed in an emergency situation, both at home or out of town?
      • If I have a preexisting medical condition, will the plan cover it?
      • If I have a chronic condition such as asthma, cancer, AIDS or alcoholism, how will the plan treat it?
      • Are the prescription medicines that I use covered by the plan?
      • Does the plan reimburse alternative medical therapies such as acupuncture or chiropractic treatment?
      • Does the plan cover the costs of delivering a baby?
    3. What is the quality of the insurance plan I’m looking at?
      • How have independent government and non-government organizations rated the plan?
        For example, the National Committee for Quality Assurance ( http://www.ncqa.org ) issues a Consumer Assessment of Health Plans (CAHPS) report for every medical plan and facility.
      • What kind of accreditation has the plan received from groups such as NCQA or the Joint Commission on Accreditation of Healthcare Organizations (JCAHO) ( http://www.jcaho.org )?
      • How many patient complaints were filed against the plan last year and how many were upheld by state regulatory agencies like the state insurance commission or the state medical licensing board?
      • How many members drop out of the plan each year? State insurance departments keep track of “disenrollment rates.”
      • Do the doctors, pharmacies and other services in the plans offer convenient times and locations?
      • Does the plan pay for preventive health care such as diet and exercise advice, immunizations and health screenings?
      • What do my friends and colleagues say about their experiences with the plan?
      • What does my doctor say about his or her experience with the plan?
    4. Can I buy an individual policy?

      5. Yes. If you are unemployed, self-employed, or decide to return to school you may want to buy an individual health insurance policy.

      Here are a number of options that you may consider:

      • Ask your insurance company if you can convert its group policy to an individual policy. You will pay a higher rate than you did before and your benefits may be limited, but the terms will still probably be better than if you buy your own policy.
      • If you are married, see if your spouse’s employer will add you to its group plan.
      • Try to join a group health plan through a trade association or alumni group or professional association may offer reasonable rates. If you are over age 50, you can join the American Association of Retired Persons (AARP), which offers an extensive plan. Even some credit card companies offer health insurance coverage.
      • As a last resort, you can buy an individual policy. The rates will be high and coverage limited, but it is important that you be protected against financial catastrophe if you or your family are hit with a major illness or injury. If you are self-employed, most of the health insurance premium will be tax-deductible.

      To find the best policy, contact a health insurance agent or broker who will help you find the contract that gives you the most for your money. Top of Page

  13. If I change jobs or become unemployed, can I bring my coverage with me?

    Answer: If you switch employers, you have the right to carry your group health insurance coverage with you to a new job for up to 18 months under the Consolidated Omnibus Budget Reconciliation Act (COBRA).

    You must pay the full premium, but at group rates that are far cheaper than the individual rates you would pay for similar coverage. Health insurance under COBRA is available if you are in the following situations:

    • You leave a company and become unemployed or self-employed for up to 18 months.
    • You are a widow or widower or child of an employee who dies while working for the same company for three years or more.
    • You are the divorced spouse or child of an employee who has left the company he or she was employed at for at least three years.
    • You are the child of an employee who left a job and have not yet reached age 23.

    NOTE: If you need COBRA benefits, you must fill out the appropriate forms from your employer’s benefits department within 60 days of leaving your job. If you do not act within that time, you may be denied coverage. Top of Page

  14. Why should I buy life insurance?

    Answer: Many financial experts consider life insurance to be the cornerstone of sound financial planning. It can be an important tool in the following situations:

    1. Replace income for dependents

      2. If people depend on your income, life insurance can replace that income for them if you die. The most commonly recognized case of this is parents with young children. However, it can also apply to couples in which the survivor would be financially stricken by the income lost through the death of a partner, and to dependent adults, such as parents, siblings or adult children who continue to rely on you financially. Insurance to replace your income can be especially useful if the government- or employer-sponsored benefits of your surviving spouse or domestic partner will be reduced after your death.

    2. Pay final expenses

      3. Life insurance can pay your funeral and burial costs, probate and other estate administration costs, debts and medical expenses not covered by health insurance.

    3. Create an inheritance for your heirs

      4. Even if you have no other assets to pass to your heirs, you can create an inheritance by buying a life insurance policy and naming them as beneficiaries.

    4. Pay federal “death” taxes and state “death” taxes

      5. Life insurance benefits can pay estate taxes so that your heirs will not have to liquidate other assets or take a smaller inheritance. Changes in the federal “death” tax rules between now and January 1, 2011 will likely lessen the impact of this tax on some people, but some states are offsetting those federal decreases with increases in their state-level “death” taxes.

    5. Make significant charitable contributions

      6. By making a charity the beneficiary of your life insurance, you can make a much larger contribution than if you donated the cash equivalent of the policy’s premiums.

    6. Create a source of savings

      7. Some types of life insurance create a cash value that, if not paid out as a death benefit, can be borrowed or withdrawn on the owner’s request. Since most people make paying their life insurance policy premiums a high priority, buying a cash-value type policy can create a kind of “forced” savings plan. Furthermore, the interest credited is tax deferred (and tax exempt if the money is paid as a death claim). Top of Page

  15. How much life insurance do I need?

    Answer: In most cases, if you have no dependents and have enough money to pay your final expenses, you don’t need any life insurance.

    If you want to create an inheritance or make a charitable contribution, buy enough life insurance to achieve those goals.

    If you have dependents, buy enough life insurance so that, when combined with other sources of income, it will replace the income you now generate for them, plus enough to offset any additional expenses they will incur to replace services you provide (for a simple example, if you do your own taxes, the survivors might have to hire a professional tax preparer). Also, your family might need extra money to make some changes after you die. For example, they may want to relocate, or your spouse may need to go back to school to be in a better position to help support the family.

    You should also plan to replace “hidden income” that would be lost at death. Hidden income is income that you receive through your employment but that isn’t part of your gross wages. It includes things like your employer’s subsidy of your health insurance premium, the matching contribution to your 401(k) plan, and many other “perks,” large and small. This is an often-overlooked insurance need: the cost of replacing just your health insurance and retirement contributions could be the equivalent of $2,000 per month or more.

    Of course, you should also plan for expenses that arise at death. These include the funeral costs, taxes and administrative costs associated with “winding up” an estate and passing property to heirs. At a minimum, plan for $15,000.

    Other sources of income

    Most families have some sources of post-death income besides life insurance. The most common source is Social Security survivors’ benefits.

    Social Security survivors’ benefits can be substantial. For example, for a 35-year-old person who was earning a $36,000 salary at death, maximum Social Security survivors’ monthly income benefits for a spouse and two children under age 18 could be about $2,400 per month, and this amount would increase each year to match inflation. (It drops slightly when the survivors are a spouse and one child under 18, and stops completely when there are no children under 18. Also, the surviving spouse’s benefit would be reduced if he or she earns income over a certain limit.)

    Many also have life insurance through an employer plan, and some from another affiliation, such as through an association they belong to or a credit card. If you have a vested pension benefit, it might have a death component. Although these sources might provide a lot of income, they rarely provide enough. And it probably isn’t wise to count on death benefits that are connected with a particular job, since you might die after switching to a different job, or while you are unemployed.

    A multiple of salary?

    Many pundits recommend buying life insurance equal to a multiple of your salary. For example, one financial advice columnist recommends buying insurance equal to 20 times your salary before taxes. She chose 20 because, if the benefit is invested in bonds that pay 5 percent interest, it would produce an amount equal to your salary at death, so the survivors could live off the interest and wouldn’t have to “invade” the principal.

    However, this simplistic formula implicitly assumes no inflation and assumes that one could assemble a bond portfolio that, after expenses, would provide a 5 percent interest stream every year. But assuming inflation is 3 percent per year, the purchasing power of a gross income of $50,000 would drop to about $38,300 in the 10th year. To avoid this income drop-off, the survivors would have to “invade” the principal each year. And if they did, they would run out of money in the 16th year.

    The “multiple of salary” approach also ignores other sources of income, such as those mentioned previously.

    A simple example

    Suppose a surviving spouse didn’t work and had two children, ages 4 and 1, in her care. Suppose her deceased husband earned $36,000 at death and was covered by Social Security but had no other death benefits or life insurance. Assume the surviving spouse is 36.

    Assume that the deceased spent $6,000 from income on his own living expenses and the cost of working. Assume, for simplicity, that the deceased performed services for the family (such as property maintenance, income tax and other financial management, and occasional child care) for which the survivors will need to pay $6,000 per year. Assume that the survivors will have to buy health insurance to replace the coverage the deceased had at work, and that this will cost $12,000 per year.

    Taken together, the survivors will need to replace the equivalent of $48,000 of income, adjusted each year for an assumed 4 percent inflation.

    Thanks to Social Security, the survivors would need life insurance to replace only about $1,700 per month of lost wage income (adjusted for inflation) for 14 years until the older child reaches 18; Social Security would provide the rest. The survivors would need life insurance to replace about $2,100 per month (adjusted for inflation) for three more years when the non-working surviving spouse has only one child under 18 in her care.

    The life insurance amount needed today to provide the $1,700 and $2,100 monthly amounts is roughly $360,000. Adding $15,000 for funeral and other final expenses brings the minimum life insurance needed for the example to $375,000.

    What’s left out?

    The above example leaves out some potentially significant unmet financial needs, such as

    • The surviving spouse will have no income from Social Security from age 53 until 60 unless the deceased buys additional life insurance to cover this period. It could be assumed that the surviving spouse will obtain a job at or before this time, but she could also become disabled or otherwise unable to work. If life insurance were bought for this period, the additional amount of insurance needed would be about $335,000.
    • Some people like to plan to use life insurance to pay off the home mortgage at the primary income earner’s death, so that the survivors are less likely to face the threat of losing their home. If life insurance were bought for this goal, the additional amount of insurance needed is the amount of the unpaid balance on the mortgage.
    • Some people like to provide money to pay to send their children to college out of their life insurance. We may assume that each child will attend a public college for four years and will need $15,000 per year. However, college costs have been rising faster than inflation for many decades, and this trend is unlikely to slow down. If life insurance were bought for this goal, the additional amount of insurance needed would be about $200,000.
    • In the example, no money is planned for the surviving spouse’s retirement, except for what the spouse would be entitled to receive from Social Security (about $1,200 per month). It could be assumed that the surviving spouse will obtain a job and will either participate in an employer’s retirement plan or save with an IRA, but she could also become disabled or otherwise unable to work. If life insurance were bought to provide the equivalent of $4000 per month starting at age 60 until 65 and $3,000 per month from 65 on (because at 65 Medicare will make carrying private health insurance unnecessary), the additional amount of insurance needed would be about $465,000. Top of Page

  16. What are the principal types of life insurance?

    Answer: There are two major types of life insurance—term and whole life. Whole life is sometimes called permanent life insurance, and it encompasses several subcategories, including traditional whole life, universal life, variable life and variable universal life. In 2003, about 6.4 million individual life insurance policies bought were term and about 7.1 million were whole life.

    Life insurance products for groups are different from life insurance sold to individuals. The information below focuses on life insurance sold to individuals.

    • Term

      • Term Insurance is the simplest form of life insurance. It pays only if death occurs during the term of the policy, which is usually from one to 30 years. Most term policies have no other benefit provisions.

      There are two basic types of term life insurance policies—level term and decreasing term.

      • Level term means that the death benefit stays the same throughout the duration of the policy.
      • Decreasing term means that the death benefit drops, usually in one-year increments, over the course of the policy’s term.

      In 2003, virtually all ( 97 percent ) of the term life insurance bought was level term

    • Whole Life / Permanent

      • Whole life or permanent insurance pays a death benefit whenever you die—even if you live to 100! There are three major types of whole life or permanent life insurance—traditional whole life, universal life, and variable universal life, and there are variations within each type.

      In the case of traditional whole life, both the death benefit and the premium are designed to stay the same (level) throughout the life of the policy. The cost per $1,000 of benefit increases as the insured person ages, and it obviously gets very high when the insured lives to 80 and beyond. The insurance company could charge a premium that increases each year, but that would make it very hard for most people to afford life insurance at advanced ages. So the comapny keeps the premium level by charging a premium that, in the early years, is higher than what’s needed to pay claims, investing that money, and then using it to supplement the level premium to help pay the cost of life insurance for older people.

      By law, when these “overpayments” reach a certain amount, they must be available to the policyowner as a cash value if he or she decides not to continue with the original plan. The cash value is an alternative, not an additional, benefit under the policy.

      In the 1970s and 1980s, life insurance companies introduced two variations on the traditional whole life product—universal life insurance and variable universal life insurance. Top of Page

  17. What are the types of term insurance policies?

    Answer: Term insurance comes in two basic varieties—level term and decreasing term. These days, almost everyone buys level term insurance. The terms “level” and “decreasing” refer to the death benefit amount during the term of the policy. A level term policy pays the same benefit amount if death occurs at any point during the term.

    Common types of level term are:

    • yearly- (or annually-) renewable term
    • 5-year renewable term
    • 10-year term
    • 15-year term
    • 20-year term
    • 25-year term
    • 30-year term
    • term to a specified age (usually 65)

    Yearly renewable term, once popular, is no longer a top seller. The most popular type is now 20-year term. Most companies will not sell term insurance to an applicant for a term that ends past his or her 80th birthday.

    If a policy is “renewable,” that means it continues in force for an additional term or terms, up to a specified age, even if the health of the insured (or other factors) would cause him or her to be rejected if he or she applied for a new life insurance policy.

    Generally, the premium for the policy is based on the insured person’s age and health at the policy’s start, and the premium remains the same (level) for the length of the term. So, premiums for 5-year renewable term can be level for 5 years, then to a new rate reflecting the new age of the insured, and so on every five years. Some longer term policies will guarantee that the premium will not increase during the term; others don’t make that guarantee, enabling the insurance company to raise the rate during the policy’s term.

    Some term policies are convertible. This means that the policy’s owner has the right to change it into a permanent type of life insurance without additional evidence of insurability.

    “Return of Premium”

    In most types of term insurance, including homeowners and auto insurance, if you haven’t had a claim under the policy by the time it expires, you get no refund of the premium. Your premium bought the protection that you had but didn’t need, and you’ve received fair value. Some term life insurance consumers have been unhappy at this outcome, so some insurers have created term life with a “return of premium” feature. The premiums for the insurance with this feature are often significantly higher than for policies without it, and they generally require that you keep the policy in force to its term or else you forfeit the return of premium benefit. Some policies will return the base premium but not the extra premium ( for the return benefit ), and others will return both. Top of Page

  18. What are the different types of permanent policies?

    Answer: There are four basic types of permanent life insurance.

    • Whole or ordinary life

      • This is the most common type of permanent insurance policy. It offers a death benefit along with a savings account. If you pick this type of life insurance policy, you are agreeing to pay a certain amount in premiums on a regular basis for a specific death benefit. The savings element would grow based on dividends the company pays to you.

    • Universal or adjustable life

      • This type of policy offers you more flexibility than whole life insurance. You may be able to increase the death benefit, if you pass a medical examination. The savings vehicle (called a cash value account) generally earns a money market rate of interest. After money has accumulated in your account, you will also have the option of altering your premium payments – providing there is enough money in your account to cover the costs. This can be a useful feature if your economic situation has suddenly changed. However, you would need to keep in mind that if you stop or reduce your premiums and the saving accumulation gets used up, the policy might lapse and your life insurance coverage will end. You should check with your agent before deciding not to make premium payments for extended periods because you might not have enough cash value to pay the monthly charges to prevent a policy lapse.

    • Variable life

      • This policy combines death protection with a savings account that you can invest in stocks, bonds and money market mutual funds. The value of your policy may grow more quickly, but you also have more risk. If your investments do not perform well, your cash value and death benefit may decrease. Some policies, however, guarantee that your death benefit will not fall below a minimum level.

    • Variable-universal life

      • If you purchase this type of policy, you get the features of variable and universal life policies. You have the investment risks and rewards characteristic of variable life insurance, coupled with the ability to adjust your premiums and death benefit that is characteristic of universal life insurance. Top of Page

  19. What is an annuity?

    Answer: In its most general sense, an annuity is an agreement for one person or organization to pay another a stream or series of payments. Usually the term “annuity” relates to a contract between you and a life insurance company, but a charity or a trust can take the place of the insurance company.

    There are many categories of annuities. They can be classified by:

    • Nature of the underlying investment – fixed or variable
    • Primary purpose – accumulation or pay-out (deferred or immediate)
    • Nature of pay-out commitment – fixed period, fixed amount, or lifetime
    • Tax status – qualified or nonqualified
    • Premium payment arrangement – single premium or flexible premium

    An annuity can be classified in several of these categories at once. For example, you might buy a nonqualified single premium deferred variable annuity.

    In general, annuities have the following attractive features:

    • Tax deferral on investment earnings

      • Many investments are taxed year by year, but the investment earnings—capital gains and investment income—in annuities aren’t taxable until you withdraw money. This tax deferral is also true of 401(k)s and IRAs; however, unlike these products, there are no limits on the amount you can put into an annuity. Moreover, the minimum withdrawal requirements for annuities are much more liberal than they are for 401(k)s and IRAs.

    • Protection from creditors

      • If you own an immediate annuity (that is, you are receiving money from an insurance company), generally the most that creditors can access is the payments as they’re made, since the money you gave the insurance company now belongs to the company. Some state statutes and court decisions also protect some or all of the payments from those annuities. And your money in tax-favored retirement plans, such as IRAs and 401(k)s, are generally protected, whether invested in an annuity or not.

    • An array of investment options, including “floors”

      • Many annuity companies offer a variety of investment options. You can invest in a fixed annuity which would credit a specified interest rate, similar to a bank Certificate of Deposit (CD). If you buy a variable annuity, your money can be invested in stock or bond (or other) mutual funds. In recent years, annuity companies have created various types of “floors” that limit the extent of investment decline from an increasing reference point. For example, the annuity may offer a feature that guarantees your investment will never fall below its value on its most recent policy anniversary.

    • Tax-free transfers among investment options

      • In contrast to mutual funds and other investments made with “after-tax money,” with annuities there are no tax consequences if you change how your funds are invested. This can be particularly valuable if you are using a strategy called “rebalancing,” which is recommended by many financial advisors. Under rebalancing, you shift your investments periodically to return them to the proportions that you determine represent the risk/return combination most appropriate for your situation.

    • Lifetime income

      • A lifetime immediate annuity converts an investment into a stream of payments that last as long as you do. In concept, the payments come from three “pockets”: Your investment, investment earnings and money from a pool of people in your group who do not live as long as actuarial tables forecast. It’s the pooling that’s unique to annuities, and it’s what enables annuity companies to be able to guarantee you a lifetime income.

    • Benefits to your heirs

      • There is a common misconception about annuities that goes like this: if you start an immediate lifetime annuity and die soon after that, the insurance company keeps all of your investment in the annuity. That can happen, but it doesn’t have to. To prevent it, buy a “guaranteed period” with the immediate annuity. A guaranteed period commits the insurance company to continue payments after you die to one or more beneficiaries you designate; the payments continue to the end of the stated guaranteed period—usually 10 or 20 years (measured from when you started receiving the annuity payments). Moreover, annuity benefits that pass to beneficiaries don’t go through probate and aren’t governed by your will. Top of Page

  20. Why should I consider purchasing an annuity?

    Answer: Annuities can serve many useful purposes.

    If you are in a saving-money stage of life, a deferred annuity can:

    • Help you meet your retirement income goals. Employer-sponsored plans such as a 401(k), 403(b) or Keogh are an important part of planning for retirement. However, contributions to these plans and to IRAs are limited, and they might not add up to enough for the retirement income you need, especially if you started saving for retirement late or had contributions interrupted—perhaps due to job changes and/or family responsibilities. Moreover, your social security and defined-benefit pension (if you have one) may provide less than you need to retire. Remember that the purchasing power of defined-benefit pension income is eroded by inflation.
    • Help you diversify your investment portfolio. Investment experts routinely advise that, to get the best return for a given level of risk, you should diversify your investments among a number of asset classes. Fixed annuities, in particular, offer a unique asset class—an investment that is guaranteed not to decrease and that will actually increase at a specified interest rate (and, often, potentially more). The guarantees are supported by the claims-paying ability of the insurer.
    • Help you manage your investment portfolio. Investment experts routinely advise that, whenever your investments in various asset classes get too far from the percentage allocations you prefer, you “rebalance” to the original formulation, by shifting funds from the classes that have grown faster to the ones that have grown more slowly. If you do this with mutual funds, you pay capital gains taxes; if you do it in a variable annuity, you don’t pay capital gains taxes. When you eventually withdraw money from the annuity (which could be many years after the rebalancing), you pay tax then at the ordinary income rate.

    If you are in a need-income stage of life, an immediate annuity can:

    • Help protect you against outliving your assets. Social security pays retirement income for as long as you live, as do defined-benefit pension plans. But the only other source of income available that continues indefinitely is an immediate annuity.
    • Help protect your assets from creditors. Generally the most that creditors can access is the payments from an immediate annuity as they’re made, since the money you gave the insurance company now belongs to the company. Some state statutes and court decisions also protect some or all of the payments from those annuities. Top of Page
  21. How much should I invest in an annuity?

    Answer: Unlike a 401(k) or an IRA, there are no limits on the amount that you can invest in an annuity.

    Whether you’re considering a deferred or immediate annuity, the amount of money you should consider putting into an annuity depends on:

    • Your immediate actual and potential financial needs
    • Your long-term financial goals
    • Your current savings/investment portfolio
    • The range of alternatives available to you

    Of these, the most important is your immediate actual and potential financial needs. If you’re buying a deferred annuity and you have a sudden need for cash, you can usually withdraw a small amount without penalty. However, you’ll likely pay a penalty if you make a large withdrawal within a few years after you’ve bought the annuity. If you’re buying an immediate annuity, you usually can’t get any more than the regular payments, no matter how badly you need cash. However, if you have other sources of cash that are sufficient for any emergency or unforeseen needs, then the immediate needs criterion is satisfied and the other criteria become more important. Top of Page

  22. How will I receive my annuity payments?

    Answer: An important decision in purchasing an annuity is deciding how you want to be paid. You can select annuity payouts for a set period of time or continue for your lifetime. With some options, a beneficiary can be designated to receive payments upon your death. You have several choices including:

    Straight life

    You will get income for your entire life—even after all the money you put into the annuity has been used up. However, if you die before the money in your account has been used up, nobody, not even your dependents, will collect payouts. The straight life annuity might be right for you if you need to maximize the amount of income you receive and either don’t have dependents or are not planning to use the annuity for the purposes of estate planning.

    Joint and survivor

    This type of annuity pays you as long as you live. After your death, it will pay the joint annuitant for the rest of his or her life. You can choose the benefit your survivor will get upon your death, but this option reduces the payout amount you get.

    Refund annuity

    This payout option is gaining in popularity. It provides income for life. If, however, you die before you receive an amount equal to all of the premiums you paid, your beneficiary gets the portion you had not yet collected. Top of Page