Life insurance can provide financial security for your family should anything happen to you. It is important to understand the different terms when getting life insurance. The face value of a life insurance policy is one of its most important components.
What is the face value of life insurance?
The face value of a life insurance policy is what your beneficiaries receive from the insurance company. This is also known as the death benefit or coverage amount. The face value is what you are paying for when purchasing a life insurance policy. If you purchase a $500,000 life insurance policy, then the face value of the policy is $500,000. The higher the face value, the higher the cost of the policy.
Life insurance face amount vs. cash value
The face value and the cash value of a life insurance policy are not the same. The face value of a life insurance policy is the coverage amount you purchase. The cash surrender value in a life insurance policy is the cash value minus any loans, surrender charges, and any other fees the insurance company may charge.
Cash value policies are permanent life insurance policies that provide insurance protection for an individual's lifetime. The premiums for permanent policies cover the cost of the life insurance policy and build a cash value within the policy. The cash value amount depends on the premium paid, the duration of the policy, and the interest rate the policy earns. Term life insurance policies do not offer a cash value.
How to calculate face value of life insurance
The face value of the policy is the death amount on the policy. It is the coverage amount you bought and life insurance companies will include it on your statement of benefits document. The face value of a life insurance policy typically does not change. However, for cash value policies, the face amount may differ if there are any loans against the policy or if there are any withdrawals.
How much face value of life insurance do you need?
The amount of life insurance you need to purchase depends on a wide variety of factors. One main factor is the amount of income or other financial support the insurance policy needs to replace to provide for your loved ones. Not calculating the amount of coverage you need is a common mistake when buying life insurance.
One rule of thumb is to multiply your annual income by 10 and add it to all your debts. If your debts total $250,000 and your annual salary is $75,000 a year, using this calculation means multiplying your salary by 10 to get $750,000, then adding the $250,000 in debts to get a $1,000,000 policy. The $1,000,000 will be the face value of your life insurance policy.
For a more individualized calculation, you can use the DIME formula. This can be a good starting point to determine how much life insurance you need. This involves adding up:
- Debt: Total outstanding bills plus the cost of final expenses
- Income: The number of years of income to replace
- Mortgage: The outstanding balance of a home mortgage
- Education: The estimated future education costs for your dependents
What factors can cause the face value of life insurance to change?
Typically, life insurance face values do not change. There are, however, some instances in which you can increase the face value of your life insurance policy.
How to increase your face value
In some cases, you can call your insurance company to see if they will increase your face value. They may require you to reapply for a new policy and undergo another health exam to replace the existing one.
Purchase additional policies
If you want to increase your face value, the most common way is to purchase additional life insurance policies. You can add multiple life insurance policies to get a higher face value overall.
Cash value growth
Cash value growth doesn't increase your face value, but it impacts how much money your beneficiaries receive from the policy. If your cash value grows to a certain level, your life insurance policy's face value may increase. This will depend on the policy.
Holding certain life insurance policies
Certain cash value life insurance policies allow you to add a rider that gives your beneficiaries both the death benefit and the accumulated cash value. You will have to pay more for this type of policy since the insurance company will have to pay more out to your beneficiaries.
Factors that can decrease face value
If you continue to pay your premiums, your face value will remain the same. If you fail to pay your premiums, your policy may be canceled. Here are some other scenarios where your face value can decrease.
Riders
A rider (also called an endorsement) is an add-on you can attach to a life insurance policy. Certain riders, such as those for terminal illness, allow you to use your death benefit for long-term care and medical purposes. Any money left over will go to your beneficiaries. A guaranteed insurability rider allows you to buy more coverage over time without having to take another health exam.
Unpaid loans
You are generally able to take out loans against a cash value policy. If you took out a loan but didn't pay it back, the insurer would subtract any unpaid amounts from the death benefit.
Lying on your application
If you lied on your life insurance application, the insurance company can either deny the insurance claim or give a partial death benefit to your beneficiaries.
How does face value affect life insurance costs?
The major factors that determine the cost of a life insurance policy is the face value, your health, and your age. Premium costs are typically lower for younger people, so don't wait to buy life insurance. The higher the face value of a policy, the higher the cost for a policy. Your premiums are directly proportional to your face value. It is important to find a face value amount that fits your budget.
