With most term life insurance policies, the death benefit — the portion of money that’s paid out to beneficiaries — works the same way. A tax-free lump sum of money is given out after the policyholder dies. The beneficiaries are then free to do whatever they want with it.
But is it really useful to get one pot of money instead of spreading it out? A different way to receive the death benefit is with a family income life insurance policy — one that treats the death benefit like an income stream instead of a lottery prize.
How a family income policy works
It’s easiest to think of a family income policy, sometimes called a family income benefit (FIB), as a term life insurance policy. The policy is active for a certain number of years (the term), at which point it expires.
Where things change is if the policyholder dies. With a traditional policy, the death benefit is paid out and that’s the end of the policy.
With a family income policy, rather than a lump sum of money, the death benefit is paid out in monthly increments as a portion of the total death benefit. The term and amount are decided on when the policy is purchased. For example, a $500,000 policy may pay out 1%, or $5,000, a month to replace lost income.
It’s important to note that the policy still ends when the term is up. In the above example, if the policyholder died five years into a 20-year term policy, it would pay out $5,000 a month for the next 15 years; if the death occurs 10 years into the policy, the monthly $5,000 would be paid out for 10 years, and so on. At the end of the 20-year term, the monthly installments end.
Other than that caveat, a family income policy acts like most other life insurance policies. You can add riders to it, for example, to customize it. However, while there are some unique benefits, there are also some unique drawbacks.
Benefits of a family income policy
A family income policy is most useful for policyholders who have young children and would benefit from having the death benefit dispersed over a longer period of time. These policies are good for people who don’t mind the diminishing death benefit — their family may need more money up front but less down the line.
Family income policies provide a constant stream of money, potentially for years. This is in contrast to the typical death benefit, which is given out as a lump sum. There are some benefits to this — mostly in that a large lump of money, potentially in the hundreds of thousands of dollars, can be hard to manage.
Some beneficiaries might be overwhelmed by their choices with that much money. A family income policy replicates getting an income from the breadwinner, so it’s more true-to-life and not as jarring to a family that’s already dealing with huge changes.
Drawbacks of a family income policy
The downside of a family income policy is that it decreases in value over time. The beneficiaries receive installments depending on when the policyholder dies — so they’ll get more money if the policyholder dies five years into a 20-year policy than they will if he or she dies 15 years into the policy.
By its nature, you get less the longer the policy is active and unused. There’s obviously a positive aspect (if the death benefit hasn’t been triggered, it means the policyholder is still alive) but unlike a traditional level term policy, where the premiums and death benefit are the same for the entire term, a family income policy will be worth less the later its triggered.
Is a family income policy worth it?
At the end of the day, it’s important for life insurance shoppers to speak to a licensed agent or financial adviser to see which policy type is right for them. A family income policy provides the death benefit in a unique way, but may not provide the full coverage needed with its decreasing value. The last thing anyone wants is to find out decades into a policy that it’s not going to be enough — so it’s crucial to make the right choice up front.
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