Life Insurance

If you're married, partnered, and/or have dependent children, you need life insurance, probably a lot of life insurance. If you're a breadwinner and anything happens to you, your loved ones will likely have enormous difficulty making ends meet. Ditto if you take care of kids or other family members at home. Single people's life insurance needs may be modest, perhaps enough just to cover what are euphemistically called "final costs." Your life insurance policy at work may be more than sufficient to cover those. On the other hand, look into the future to determine if there may be situations where a more than minimal coverage may be necessary. Perhaps your parents may eventually need financial support or your siblings aren't very well off financially and, had you survived, you may have been able to help them pay college costs for your nieces and nephews. In these instances, you may need more than a small amount of coverage.

How much life insurance do you need? The rule of thumb is to buy about five to eight times your current wages. If you make $50,000 per year, that's $250,000 to $400,000 of life insurance coverage. Another approach would be to secure enough coverage to meet major financial obligations, enough to pay off the mortgage(s) plus pay for the kids' college educations. On top of that, an additional sum could be provided to help the family transition from the loss of your income.

Term or cash value life insurance? There are two primary types of life insurance.

1. Term insurance is just plain insurance with no bells and whistles, and generally is cheapest, particularly for younger people. You can buy "annually renewable" term insurance or "level term" insurance, which charges the same premium over a fixed term of say 5, 10, 20, or even 30 years.

The downside of level term insurance is it provides protection only for a specified period. If you die during that period, that's great - from the standpoint of collecting on the policy. Hopefully, though, you'll live a long life, and when the term expires, you'll have tons of money saved, the mortgage will be paid off, and the children will be out of the nest (if they ever leave the nest), so you won't need the insurance.

On the other hand, you can keep renewing an annually renewable term policy, but beware:

  • The annual premium will most likely rise and eventually become prohibitively expensive.
  • Some insurance companies may require you to take a medical exam before letting you renew coverage. If you have a medical condition, you could find it tough to get insurance or the cost of your insurance may rise substantially.

2. "Cash value" life insurance policies come with more than insurance and they generally provide lifelong coverage. They give you protection with savings. There are several types of cash value policies, including:

  • Whole life lets you lock into your premium payments for permanent protection. Your payments go both to a specific death benefit and a cash value savings account, which grows income tax-free. With whole life insurance, you get dividends, which may be used to buy more insurance, pay premiums, or to slash the number of years you pay premiums. The downside: Whole life usually pays relatively low interest rates that are set by the life insurance company. You can do better investing on your own. Hence the often bandied: "buy term and invest the difference." But that doesn't mean whole life or other cash value insurance shouldn't be purchased, as discussed below.
  • Universal life lets you adjust your premium payments. This can be attractive if you're in a career or business that has periods of unusually high or low income. But when interest rates are low, your cash value usually earns a lot less than whole life. Also, if you slack off on payments, your policy could be canceled.
  • Variable universal life insurance also lets you make flexible premium payments. But it also lets you invest the cash value in a selection of investments, including as stock and bond mutual funds. The downside: If the stock market plummets, like it did from 2000 to 2002, you could see your stock fund holdings within the policy decline substantially. In fact, you may need to cough up some additional cash to keep the policy in good standing.

Optional extras. "Riders," which range in cost from $50 to several hundred dollars annually, can fine-tune your insurance coverage. Depending on your situation, some may be worth the extra money, but most are probably not. Here are the most common:

  • Guaranteed insurability rider: Lets you increase your insurance coverage without taking a medical exam or buying a new policy.
  • Disability income rider: Provides some disability insurance coverage if you're unable to get it elsewhere.
  • Accelerated death benefit: Also called a living benefit, it will pay the life insurance proceeds while the insured is still alive but is terminally ill.
  • Double indemnity or accidental death benefit: Lets your beneficiaries collect double the death benefit if you die in an accident.
  • Automatic premium loan provision: Covers your premium payments in the event you cannot or choose not to pay a premium. The insurance company pays the premiums as a loan against the policy's cash value.
  • Waiver of premium: Covers your life insurance premiums if you get injured or disabled. It's not designed, however, to be a substitute for disability insurance, which covers your income.
  • Family rider: Lets you buy term insurance for other members of your family with your whole life coverage.

Which type of life insurance is best for you?

  • How long you'll need the coverage. The primary life insurance question to resolve is how long you expect to need the coverage. If your life insurance needs are likely to decline at some point in the future, when the kids get out of college, for example, than term insurance is the answer. On the other hand, if you expect your life insurance needs to continue indefinitely, to help support your spouse or partner in retirement, for example, then cash value insurance, aptly called "permanent insurance," is the safer choice.
  • Affordability. Cash value policies are very expensive if you need a lot of coverage. If cost is a problem but you may need insurance for a long time in the future, it's probably better to buy a long-duration level term policy, say 30 years.
  • Part term, part cash value. Like most dilemmas in your financial life, the best kind of life insurance coverage for you is not an either/or decision. You may want to opt for term insurance for temporary needs and cash value coverage of indefinite duration insurance needs.
  • Better investment returns available elsewhere. Finally, the investment feature of a cash value life insurance policy should not be considered the foundation of your lifelong investment program. While you can build up substantial values within many policies, they should not be viewed as a substitute for saving and investing the old-fashioned way.

Shop for coverage. If you're in the market for life insurance coverage, be sure to shop, or ask your agent to shop for the best deal offered by a financially strong life insurance company. Premiums for essentially identical coverage vary widely, and this is one area of insurance coverage where price is a major consideration. If you already have a term policy, you may benefit from shopping for new coverage.

Life insurance tips for empty nesters and retirees. If the children are on their own, if the mortgage is paid off, and/or if you're in excellent financial shape, you may not need to continue some of your life insurance coverage. But this is a decision that shouldn't be taken lightly. Also, if you're well into retirement, it could pay to tap the cash value of a policy you've had for a long time. This may be attractive if it's paid up in full or "endowed," and you already have substantial assets. Evaluate the suitability of taking out a low-interest tax-free policy loan. Then, put the money to work elsewhere or, better yet, take an expensive cruise.