Common questions about life insurance

Do I need life insurance if I’m single?

Single people with no children often don’t need life insurance because no one is relying on their income. But there are some reasons why you might need life insurance if you’re single. If you died, who would pay for your funeral? Even a simple ceremony could be costly. If you don’t have life insurance, someone else (e.g., your relatives) may have to foot these bills. Even if you have only a small policy, the death benefits could be used to cover these expenses.

Do you have debts in excess of your assets, or do you owe money together with someone else? Perhaps you’re a joint debtor with your sister on her mortgage. If you died, she’d be responsible for the entire debt. Would she be able to make the monthly payments on her own? A life insurance policy naming her as your beneficiary could give her enough funds to cover your share of the mortgage, or perhaps to pay off the entire debt.

Finally, is it possible that your health will deteriorate? Maybe you have a family history of cancer or heart disease. If that’s the case, you might have trouble buying life insurance later when you’re older, especially if your health has begun to decline. Even if you’re single now, you may be wise to buy life insurance now before it gets too expensive or you become uninsurable. After all, you may not stay single forever.

What is Group Life Insurance?

Group life insurance is a type of life insurance in which a single contract covers an entire group of people. Typically, the policy owner is an employer or an entity such as a labor organization, and the policy covers the employees or members of the group. Group life insurance is often provided as part of a complete employee benefit package. In most cases, the cost of the group coverage is far less than what the employees or members would pay for a similar amount of individual protection. So, if you are offered group life insurance through your employer or another group, you should usually take it, especially if you have no other life insurance or if your personal coverage is inadequate.

As the policy owner, the employer or other entity keeps the actual insurance policy, known as the master contract. All of those who are covered typically receive a certificate of insurance that serves as proof of insurance but is not actually the insurance policy. As with other types of life insurance, group life insurance allows you to choose your beneficiary.

Term insurance is the most common form of group life insurance. Group term life is typically provided in the form of yearly renewable term insurance. When group term insurance is provided through your employer, the employer usually pays for the most (and in some cases all) of the premiums. The amount of your coverage is typically equal to one or two times your annual salary.

Group term coverage remains in force until your employment is terminated or until the specific term of coverage ends. You may have the option of converting your group coverage to an individual policy if you leave your employer. However, most people choose not to do this because these conversion premiums tend to be much higher than premiums for comparable policies available to individuals. Typically, only those who are otherwise uninsurable take advantage of this conversion option.

Will I be taxed on the growth of the cash value of my life insurance? What if my policy pays dividends? 

One of the advantages of cash value life insurance is that any earnings in the cash value do not incur a current tax liability. In general, any earnings in the cash value are allowed to grow on a tax-deferred basis until one of the following events occurs:

• The policy is surrendered (meaning you cash it in)
• The policy is transferred for value (you sell it or assign it, etc.)
• The policy ceases to meet the IRS definition of a life insurance contract

Typically, there is no tax liability until one of these events occurs because of the substantial limitations and restrictions on receiving distributions from the cash value. Generally, if you receive the proceeds under a life insurance contract as a beneficiary due to the death of the insured person, the benefits are not includable in gross income and do not have to be reported; any interest you receive is taxable and you should report it just like any other interest received.

Some life insurance policies (known as participating policies) pay dividends to their policyholders. Dividends are generally not taxed as income to you. Instead, they are considered a return of your premium regardless of whether you receive them in cash, use them to purchase additional coverage, use them to reduce future premiums, or leave them invested with the insurance company. However, if your dividends exceed the total premium payments for the insurance policy, the excess dividends are considered taxable income. If you leave your dividends invested with the insurance company, the interest earned on this investment will be considered taxable income.

Policy withdrawals are not subject to taxation up to the amount paid into the policy. Policy loans and/or withdrawals will be taxable to the extent of gain if the policy is a modified endowment contract. Policy loans and/or withdrawals also reduce the cash surrender value and policy death benefit and increase the chance that a policy will lapse. Taking a policy loan could have adverse tax consequences if the policy terminates before the insured's death.

When I die, is my beneficiary required to take a lump-sum payment of my life insurance death benefit?

It isn’t necessary for your beneficiary to take a lump sum, although many people prefer that option. Many settlement options for life insurance proceeds exist. Some of the more common options are as follows:

• Interest option, where the life insurance company retains the proceeds and pays only the interest earned to the beneficiary at regular intervals
• Fixed-period option, where the company pays the proceeds together with the interest at regular intervals for a fixed period of time
• Fixed-amount option, where benefits are paid in fixed amounts at regular intervals until the proceeds and the interest are depleted
• Annuity option, where the proceeds and the interest are used to provide regular payments to the beneficiary for the remainder of his or her life
• Lump sum, where the life insurance company pays the total amount of the benefit in one single payment at the death of the insured

Your beneficiary may have flexibility within the options, as well. For example, if your beneficiary chooses the fixed-amount option, your beneficiary might elect to receive $250 per month for the first five years, and then $500 per month until the proceeds are depleted. Your beneficiary may also choose a combination of options. For example, your beneficiary could receive the interest options until retirement and then receive the remainder of the benefit as an annuity.

Your life insurance company will allow your beneficiary to choose how the proceeds are received when they become payable. If you think it’s necessary, you may choose how the beneficiary will receive the proceeds when you purchase the policy. Consult your financial professional to see what choices your life insurance company offers.

Will my beneficiaries have to pay taxes on the proceeds of my life insurance policy?

If you mean the death benefits of the insurance policy, then these funds are generally free from income tax to your named beneficiary or beneficiaries.

You may elect to have the insurance company hold on to these proceeds after your death and distributed them to your beneficiary at a later date or in a series of installments. The fund that the usurer holds are earning interest, and when a payment is made to your beneficiary, it may include both principal and interest earned by that principal, or only interest. Although the principal portion of the payment is tax free, the interest portion is taxable to your beneficiary as ordinary income.

In some cases, if you transfer the ownership of your life insurance policy to another party before your death for monetary value or other consideration, the proceeds paid to the beneficiary at your death could be considered taxable income to that beneficiary. This is a complicated matter, and you should seek the assistance of a tax professional before completing the transaction.

The proceeds of your life insurance policy may be subject to federal estate taxes if you have what’s known as incidents of ownership in the policy. If you control the policy in any way—that is, you can cancel it, surrender it, borrow against it, pledge or assign it, or can change the beneficiary—then you possess incidents of ownership in the policy, and the proceeds of the policy may be subject to federal estate taxes when you die. You might postpone these estate taxes if the proceeds of the policy are to go to your spouse, but the taxes might come due later when your spouse dies. Again, these issues are complicated; seek the advice of a qualified professional when planning your estate.