Life Insurance

About 6 minutes
 
Let’s face it. No one ever likes to think about dying. But it is a fact of life. And if anyone relies on you financially (a spouse, a child, or even a parent), you don’t want to leave them unprotected if you die unexpectedly. This is where life insurance comes in.
 

What is life insurance?

Life insurance is a contract between you and an insurance company. The basic idea is that you’ll pay premiums while you’re alive, and your dependents, named as beneficiaries in your policy, will receive money when you die. This can come as a lump sum at your passing or as periodic payments over time.
 
And while the money might not cover them forever, it should at least help ease their financial burden.
 
We should also point out, it’s not just for primary wage earners. Even if you’re a stay at home parent, it’s still a good idea to have life insurance. After all, paying for household management could get expensive if you’re no longer around.
 

What are the different types of life insurance?

As always, we’re glad you asked! If you’ve ever looked into life insurance, you’ve probably come across a wide array of products with confusing sounding names.
 
Generally though, they fall under two main categories;
 
1) Term life
 
2) Permanent life

 

Term life insurance

Term life insurance provides coverage for a specified period of time, or term. Once the term is up (or you stop paying your premiums), you’ll cease to have coverage.
 
It’s basically intended to cover your dependents until they’re no longer dependent (i.e. your kids have grown up) or until you’ve accumulated enough other wealth to ensure they’re protected.
 
Term options generally come in increments of 5 years (5-year, 10-year, 15-year, 20-year, 25-year, and 30-year). Annual renewable term life insurance (ART) is term life insurance with a term of one year. At the end of the year, you can choose to renew, but the premium may be higher.
 
Even within the category of term life insurance, there are two types to consider: level term and decreasing term.
 
As the name suggests, level term life insurance will pay out the same amount at any point throughout the term of the contract.
 
With decreasing term life insurance, the coverage decreases with time. This could be used to protect family members from the costs of a specific liability that decreases over time, like a mortgage.

 

Permanent life insurance

Unlike term life, permanent life insurance does not expire at the end of a term. Your coverage will remain in effect as long as you keep paying your premiums.
 
The way it works is also a little more complicated than term. In addition to paying out a death benefit the way term life does, it serves as an “investment” product in that it accumulates a balance, or cash value, over time (so part of your premium payment goes towards the insurance and part goes towards the cash value, which also earns interest). But, this added benefit comes at an added cost – permanent life is more expensive than term.
 
There are two common types of permanent life insurance; whole life and universal life.
 
Whole life insurance offers a death payment in addition to a guaranteed rate of return on your cash value, and your premiums will be fixed for the rest of your life. Variable life is similar to whole life, except the return on your cash value is not guaranteed. Instead, it’s tied to an underlying investment portfolio that you can choose.
 
Like whole life, universal life insurance is still a type of permanent life (your insurance won’t expire at the end of a term). However, with universal life, you’re premium payments aren’t fixed – you can increase/decrease how much you pay depending on your financial situation. If you don’t pay enough to cover the cost of your insurance though, it will automatically be deducted from your cash value balance.
 

So what’s better? Term life or permanent life?

Like most financial questions, this somewhat depends on your particular situation, but there are three big reasons why it can make more sense to choose term life.
 
Reason #1: If you’re only looking for “pure insurance” and want to you invest your money separately. While permanent life might help if you simply can’t force yourself to invest any money, you’re generally better off investing separately through a 401(k), IRA, brokerage or robo-advisor. The investment choices offered with a permanent life insurance plan can be limited and may charger higher fees.
 
Reason #2: If you only need life insurance to cover a set period of time, for example while your children are dependent on you or while your mortgage is outstanding. Ideally, when the term is up, you’ll have saved up enough money to cover your dependents (or they’ll no longer be dependent).
 
Reason #3: If you’re looking to save money. Permanent life is usually much more expensive than term life since it’s open ended and because of the investment component (some of the money you pay will go towards the cash balance). Additionally, you may end up paying a higher commission when you buy it.
 

How much coverage do I need?

To figure this out, you’ll want to think about what future expenses you would want covered. The cost of the funeral? Future mortgage payments? General living expenses for your loves ones? Education expenses for you children? These will add up, so make sure you get enough to cover everything you need.
 
Then, shop around. Talk to a few different agents and browse online. Make sure you understand how various policies work and find one that’s right for you.
 
And when you do talk to insurance agents, be aware of their incentives. Some might try to sell you plans with higher commissions that may not be best for you.
 
Also, even if you have life insurance through work, it might not be enough to cover your needs. You may need to buy supplemental coverage.
 

Cost and risk

As you start shopping for life insurance, it’s important to remember that insurance providers are in the business of making money, which means the riskier you seem in their eyes, the more expensive your insurance will be. Yes, it may sound morbid, but insurance companies need to estimate the likelihood of you dying over a given time period and then price the your premiums accordingly.
 
So for the most part, the cost of your premiums will depend on your age and your overall health and you may even be required to get a physical first. Younger and healthier means cheaper insurance.
 
Of course the cost of your insurance will also increase if you want more coverage too.
 

You might need to think about taxes

As with any financial product, it’s important to consider the impact of taxes. For the most part, your life insurance beneficiaries will not be required to pay income tax on insurance proceeds, which is good.
 
However, there are instances where the proceeds may be considered part of the estate of the deceased, in which case they can be subject to estate taxes. This would be the case if you named your estate as the beneficiary for your policy.
 
We won’t get into the detail here, but if you need more help, you may want to work with an estate attorney or a financial professional. We’ll also cover some more details in the next section, which is all about estate planning.
 

Keep your information up-to-date

Getting life insurance is a big, bold, financial step, so congrats if you’ve done it! But you aren’t completely home free yet.
 
You also need to periodically review your policy and be sure to keep your personal information and beneficiary information up-to-date as your financial situation changes (or as your number of beneficiaries increases/decreases).
 
It’s a good idea to do this at least once a year. Add it to your calendar so you don’t forget.
 
 

Key Take-Aways

1) Life insurance pays out when the person who owns the policy dies and can be used to help protect financially dependent people.

2) Term life insurance is set for a specific period of time. As long as you keep paying your premiums, you’ll be covered for the term.

3) Permanent life insurance lasts for the rest of your life and also typically has an investment component to it.

4) In general, if you’re looking for “pure insurance”, you’ll be able to save money by choosing term life insurance instead of permanent life insurance.

5) It’s important to shop around for insurance and to make sure you buy enough coverage to meet your specific needs. You’ll also want to periodically review your plan to make sure your beneficiary designation and other details are current.

 

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