The old saying is that there are only two guarantees in life: death and taxes. Obviously, no one likes either one. People like to complain about taxes, but rarely do we talk about death. We have to talk about death because someday, you will die. There is no doubt about it; you just don't know how and when. Since we don't know the how or, more importantly, the when of our demise, we need to have life insurance to protect our family.
Life insurance, quite simply, is a promise to pay money when the insured person dies. In return for this promise, someone (usually the insured person) pays an agreed upon amount every year to the insurer. Anyone who receives the payment upon death is known as a beneficiary. The person covered is the insured.
Before you choose a type of life insurance, you need to figure out why you want it. Some of the issues you should consider when selecting insurance include:
- Do you have a mortgage and other debt that you want paid?
- Do you have children whose college expenses you want to fund?
- Do you have a spouse that will be raising children without your help or your income?
- Do you want to leave an inheritance to your family?
- How much do you want to spend on insurance?
- How old are you now and how much longer will you be financially responsible for your children?
Types of Insurance
There are three basic categories of life insurance: term, whole/universal, and variable universal. Depending on the insurance company you use, you may find more options, but they are usually variations of the three basic types.
Term Life: Term life insurance is the least expensive. You choose a fixed period that you want coverage, normally 20 to 30 years. The insurance company then gives you a fixed premium for that period. The healthier you are, the lower the premium, since the odds of you dying while covered are lower. If you smoke, expect your premium to be nearly double. With term life, you can ensure coverage just for the years of your life when you are responsible for kids and mortgage payments. However, if you outlive the coverage, but still want a policy, the premium will skyrocket. If you don't die during the coverage period, you (or your family) get nothing for all the years of premium payments.
Whole or Universal Life: There are a number of variations of whole and universal life, but they normally share several common themes. First, you will die during the coverage period... you are covered for your life. As a result, the premiums are much higher than term (it can cost 10 to 15 times more than term life per year for the same coverage). Second, they often have a cash value, which means that part of your premium is used to build a type of retirement account. You can cash out the policy or borrow from it, both with negative consequences on any death benefits. The premium payments may be fixed for life, or you may have the option of adjusting coverage or cash value to affect your premium amounts. The cash value normally has a fixed return, which can be comforting in poor economic times. Early purchase of a whole life policy can ensure that a child has coverage, even if he/she develops a serious illness later in life. However, if you reach a ripe old age and outlive your spouse, your insurance policy may become nothing more than an inheritance check for your adult children. The interest paid on the cash value will normally be worse than what you could have earned in a good mutual fund.
Variable Universal Life: This is a policy that takes many of the aspects of a universal life program, but adds in the ability to invest into mutual funds and use your cash value in the stock market. Because the performance of the stock market affects the value of the insurance policy, the payments can fluctuate dramatically. For the promise of greater returns, you will be passing up any guarantees. You will be insured for life, but your premium payments and your ultimate death benefit could fluctuate.
How do you choose?
That's a good question. Each person has different needs and expectations, but here's my take on it:
If you research life insurance, you will find that the only people recommending whole and universal life insurance are the people selling it. In law enforcement, we call that a clue. The insurance companies make lots of money on these policies; thus so do the sales people.
I have yet to find a consumer advocate or financial advice columnist that believes a person should have anything other than term life insurance. For most of us, term life makes the most sense. We can get enough coverage to pay off our debts, get the kids off to college and support our spouse for a few years. The cost to do so is very low; literally a few hundred dollars per year. You probably spend more on car insurance.
While leaving an inheritance may be a nice idea, most of us don't need to spend thousands of dollars extra per year to ensure that our kids get a bigger check when we die.
Someday, you will die. Make sure you have a financial plan for those you are leaving behind.