Apart from the costs, one of the main reasons why Americans don’t bother getting life insurance is the lack of a better understanding of it. In other words, it’s tough to really answer the question of “What Type Of Life Insurance Is Right For Me?” if you don’t know anything about it.
What Is Life insurance?
Life insurance (or life assurance, especially in the Commonwealth of Nations) is a contract between an insurance policy holder and an insurer or assurer, where the insurer promises to pay a designated beneficiary a sum of money (the benefit) in exchange for a premium, upon the death of an insured person (often the policy holder). Depending on the contract, other events such as terminal illness or critical illness can also trigger payment. The policy holder typically pays a premium, either regularly or as one lump sum. Other expenses, such as funeral expenses, can also be included in the benefits.
Life policies are legal contracts and the terms of the contract describe the limitations of the insured events. Specific exclusions are often written into the contract to limit the liability of the insurer; common examples are claims relating to suicide, fraud, war, riot, and civil commotion. Difficulties may arise where an event is not clearly defined, for example: the insured knowingly incurred a risk by consenting to an experimental medical procedure or medication resulting in injury or death.
Modern life insurance bears some similarity to the asset management industry and life insurers have diversified their products into retirement products such as annuities.
Life-based contracts tend to fall into two major categories:
- Protection policies: designed to provide a benefit, typically a lump sum payment, in the event of a specified occurrence. A common form—more common in years past—of a protection policy design is term insurance.
- Investment policies: the main objective of these policies is to facilitate the growth of capital by regular or single premiums. Common forms (in the U.S.) are whole life, universal life, and variable life policies.
Types of Life Insurance
While you’ve probably been overwhelmed by the different types of life insurance (Variable life, Guaranteed Universal, Accidental Death, etc.,), in general it can be categorized into two: Term Life and Permanent Life Insurance.
So what’s the difference between the two, you ask? Well, to keep things simple, I like using the analogy of renting versus owning a house.
Term Life Insurance can be thought of as “renting”. For example, you pay monthly dues for your apartment so you can have a place to live in for a set amount of time. It’s cheaper, however, you don’t have any ownership in the property. After the contract (term) expires, you’ll have to renew it, and almost always at a higher price than the previous contract.
Permanent Life Insurance is like “owning” a house. It will be more expensive than renting an apartment (term) but the price will remain level for life (like a mortgage). Since it’s designed to last a lifetime, protection will continue until your death.
No need to renew it after 20 years, for example. Also, one important feature of permanent life insurance is its cash value. Like building equity on your home, the money you allocate to pay the premium creates cash value that grows tax-deferred at the guaranteed interest rate.
- Term Life Insurance
- Gives you the most protection for your money dollar for dollar
- Provides coverage for a set amount of time
- Price to renew coverage will be higher
- No cash value
- Permanent Life Insurance
- Coverage lasts as long you’re paying premiums
- Cash value compounds and accumulates free of taxes
- You can collect the cash value (after the first few years) tax-free as long as it doesn’t exceed your premiums
- Typically, quite a bit more expensive than term life
*Note that this comparison is under the assumption that the client is healthy
So which of the two is better? Answer—it depends. In reality, no two persons will have the same needs or situation to allow us to recommend only one type of insurance all the time.
The number one factor that affects the decision when choosing between the two? Cost.
Term life insurance is significantly cheaper compared to a permanent life insurance. It’s recognized as the easiest way of getting life insurance because the way it works is pretty much straightforward.
Just note that it will only cover you for the term of the contact (10, 20, 30 years), after which you’ll have to renew it at a higher price. Note that most people don’t have a reason to renew it because the kids will be out of the house and they been saving over those years as well.
On the other hand, permanent life insurance is perhaps the best choice for people looking for lifetime coverage and protection. It’s also the right pick for anyone looking for some sort of asset build-up strategy for boosting their bottom line.
Pros and Cons of Life Insurance
- Financial security and peace of mind for your family or spouse
- Flexibility to use the funds from life insurance as the beneficiary sees fit
- Fixed premiums so you know what to expect in your budget
- Permanent life insurance offers the possibility of building savings through investments (may also allow the option of borrowing money from the life insurance policy later in life if needed)
- For term life, after the term is up if the death benefit is not paid, any premiums paid into the policy are lost
- For whole life with cash values or universal life, investment options do not yield the highest possible returns
- If you do not pay the premium, your policy will be canceled and you may have to take out a new life insurance policy, subject to your current age and a new medical exam
Why Do I Need Life Insurance?
If you have someone relying on you financially, it’s simply a must. It will help compensate for the loss of income that goes along with the loss of life. Also, it helps ease the financial burden for the surviving family both for funeral and burial costs and while they’re adjusting financially during the first few months or years.
It’s especially crucial if you have children. A life insurance policy gives you the peace of mind that your loved ones and surviving family will have financial assistance when you die. Lastly, if you have existing loans or debts, life insurance can help to pay them off, including estate taxes.
When Should I Buy Life Insurance?
Some experts say that the optimal age is 35, however, it could be earlier or later depending on your situation, as ultimately the deciding factor will be if you have someone that relies on your financial support.
Delaying it too much can be costly. For example, let’s say the average price of a 20-year level policy that has a face value of $100,000 is $160 annually for a healthy 30-year old male. That’s significantly lower versus the $220 per year that a 40-year old male will need to pay.
Also, medical conditions might develop as a person ages so the chances of being assessed for a higher monthly premium will also increase.
What Type Of Life Insurance Is Right For Me?
Now that the differences and strengths of each option are clear, it’s now time to take what we learned and apply it for making a sound decision based on various situations and lifestyle.
- Single without dependents – If you don’t have anyone who depends on you financially, life insurance isn’t exactly a must. Perhaps you might consider a cheap and simple policy instead for funeral and burial costs so you can help your loved ones with the expenses. Otherwise, you probably don’t need any.
- Newly-married – Couples usually have access to better coverage and rates if they combine their policies under the same company, for example. Also, life insurance policies will get pricier as you both age so getting one when you get married can help you land a more affordable policy.
- Bought a new house recently – It’s a good idea to get at least term life insurance after purchasing a new home. Protecting against the loss of income should the person paying the mortgage pass away is important.
- Expecting a baby – Arguably the best time to get insurance. It’s important to get coverage to ensure financial support for the child and the surviving spouse.
- Approaching retirement – It’s usually around this time when people’s coverages start to expire. If you try to get a new policy, the price will be significantly higher.
There are a lot of options to choose from when deciding on what kind of life insurance you need. Your age and personal situation will dictate what the most needed life insurance coverage is for you, as well as how much you can afford.
- Consider that term life insurance can be used for short term needs in combination with convertible or permanent life insurance options to save money, especially when you are starting out.
- Always review your life insurance choices every few years or whenever your family situation changes, including the amount of the death benefit and who the beneficiaries are.
- Getting the opinion of licensed life insurance or financial advisors when you are making your choice is strongly recommended because it can help you find ways to afford the right kind of coverage and ensure you don’t end up going without life insurance because you are worried about the costs