2022 AFBA Financial Planning Guide

period has been selected, it cannot be modified unless the beneficiary wishes to withdraw all remaining funds in one lump sum. b. Payments of a Stated Amount. This approach is similar to the stated period option except that it allows the beneficiary to establish the size of the periodic payment rather than the number of years over which the money will be received. This option generally provides a greater degree of flexibility since most companies allow the beneficiary to subsequently change the payment amount. c. Life Income. This method guarantees a certain payment level to the beneficiary for the remainder of his or her life. Most companies will ensure the continuation of payments for a minimum number of years. Consequently, if the primary beneficiary dies before the minimum period has elapsed, payments will continue to a secondary beneficiary until the minimum payment period has been satisfied. While each of the payment options discussed above has its pluses and minuses, many insurance advisors recommend that it is in the best interest of the beneficiary to receive the insurance proceeds in a single lump sum and temporarily deposit the funds in either a money market deposit account or some other insured savings vehicle. This approach provides the beneficiary with a safe and financially flexible mechanism during the period immediately following the death of the insured. Subsequently, the beneficiary can move the funds into an investment vehicle of his or her choice. It is important to note that life insurance benefits are generally not subject to income tax at either the state or federal level. Suicide Clause. This provision, which is usually required by state law, stipulates that the policy will not pay the death benefit if the insured commits suicide within the first two years of the policy purchase date. After two years, most state laws require that suicide is one of the risks covered by the policy and the designated beneficiaries will receive the same death benefit that would be payable under any other cause of death. 13–10. HOW MUCH LIFE INSURANCE? There are two common methods for determining an individual’s life insurance requirement, the “multiple earnings” approach and the “needs” approach. Multiple Earnings Approach. Under this model, the required amount of life insurance is a direct function of the insured’s

annual income level. One version of this approach multiplies current earnings by a factor of 7 to 10 and increases that amount by the value of the unpaid home mortgage plus $50,000 for each child living at home. Example: A member with a spouse, two children in high school, $150,000 outstanding mortgage, monthly gross income of $5,000. Required Insurance: Salary: $5,000 x 12 x 7 = $420,000 Outstanding Mortgage Balance = 150,000 Children: $50,000 x 2 = 100,000 Total Insurance Requirement = $670,000 Needs Approach. This technique of estimating insurance requirements examines the financial situation of the insured and considers other resources that may be available. While it takes more effort than the multiple earnings method, it will produce an estimate that is specifically tailored to an individual’s situation. The worksheet at the end of this chapter provides an outline for developing insurance requirements under the “needs” approach (see section 13–14). 13–11. RISK CLASSIFICATION. Most insurance companies have different premium charges — standard, substandard, and preferred — for different risk classes. The standard risk class is made up of individuals whose health, life style, and employment is regarded as average. Most individuals are included in the standard risk class. Substandard rates, which are higher than standard rates, are charged on policies where the insured is determined to be a higher risk than the average individual (i.e. smokers). Preferred rates, which are lower than standard rates, are charged on policies where the anticipated mortality of the insured is lower than the standard risk class. Individuals in the preferred class do not smoke, are generally in excellent physical condition, and have a good family medical history. 13–12. SELECTING A LIFE INSURANCE COMPANY. The selection of a sound company is critical to your insurance planning. The company’s ability to pay is a function of its financial strength which is a direct result of its management practices and investment strategies. Fortunately, there are a number of rating services which evaluate the insurance industry. A review of this information can help with the selection process. However, each service has its own rating system and since they are making independent judgements, they do not always agree on the claims paying ability of a given company. Consequently, it is prudent to check the

CHAPTER 13: LIFE INSURANCE

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