While insurance isn’t an investment, it’s an important part of sound, savvy personal financial management. Insurance is protection. It protects everything you’ve worked so hard to earn. It protects your spouse in the event of premature death. It sends the kids to college. It holds together a family at a time when money shouldn’t be a concern.
You need insurance but shopping for the right coverage to protect your family and your assets is like learning a new language. Term life, whole life, universal life, actual cash value, dividends, loans against policy – it’s a maze of insurance products out there and finding the right coverage for your needs may take a little research.
Here’s a starter course on getting the most for the least in life insurance and still have the protection you and your family need.
Types of Life Insurance
There are two basic types of life insurance with numerous variations on a theme.
Term life insurance is the simplest to understand. It’s also the most economical protection you can buy.
Term life insurance is paid when the insured (you) pass on within a defined term – a defined length of time your life insurance coverage is in effect. Term life comes with a variety of time frames: five-, ten- even thirty-year terms are available.
The younger you are, the lower the cost of the monthly premium – the dollar amount you pay for protection each month. Premiums are calculated based on two factors – your age (and general health) and the dollar amount of protection you need. It’s simple. A $100,000 term life insurance policy won’t cost as much as a $500,000 policy because you’re buying less protection.
With term life, you keep things simple. The insurance company pays X amount of dollars to the beneficiaries when the insured individual passes on, as long as the policy is in effect, that is, the death occurs during the term of the policy, thus the name term life insurance.
Term life policies don’t accumulate value, you can’t borrow against them and, if you choose a short term and your health changes, you could end up paying more for your term life insurance than you would if you buy a long-term policy – one that covers you for the long term.
To determine how much term life you need, add up funeral costs, outstanding personal debt, mortgage debt, the prospect of paying tuition and other large expenses that would drain family resources. Figure what it would cost your family for a single year.
Then multiply by a factor between 5 and 10. Use the lower factor if you don’t have a lot of debt and the higher factor if you’re carrying a couple of mortgages and you have three kids to put through school. That’s how much term life you need to protect your family and all their expectations.
The other class of insurance is whole life insurance, also called permanent insurance, universal insurance, variable universal insurance and other product names, but all fall into the general class of coverage called whole life insurance.
The first difference between term and whole life is that whole life covers you from the day you buy the policy until you die. Of course, this assumes that you pay your whole life insurance premium each month. There is no term (length of time coverage is in effect) to whole life. Buy it when you’re young and your premiums will be low and you’ll start building cash value.
That’s the other main difference between term and whole life insurance coverage. Whole life pays dividends. Not a lot, but dividends that can be used to lower monthly premiums, or they can be allowed to accumulate earning interest.
Once the whole life policy has accumulated enough cash value you can borrow against that cash value to buy a house or cover some tuition bills. The downside to taking loans against the value of a whole life policy is that it lowers the payout to family in the event of the insured individual’s death.
However, a whole life policy does increase in value while providing protection for your family. The cost of coverage is also higher. Expect to pay more for $500K of whole life versus $500K of term life insurance, simply because the insurer is paying interest on your monthly premiums.
Calculate your coverage needs using the criteria listed above. Don’t think of whole life as a money-maker. It’s not intended to increase your wealth. That’s a side benefit. An important side benefit, but the primary reason for purchasing whole life is to protect your family in the event of your pre-mature death.
Life Insurance Sources
There are hundreds of insurance companies and even more life insurance products so talking to a knowledgeable professional is a good first step.
An insurance broker can advise you but, keep in mind, each insurance broker carries a “line” of products from a limited number of insurance providers so each broker will tell you her products are the best value.
If you do the math yourself, you know going in, how much coverage you want to buy, at which point, it’s just a matter of finding a reputable insurance company offering competitive rates and the benefits you’re looking for.
Another resource is your local bank – often the best place to start researching your life insurance needs. Banks sell a broad range of life insurance products and, because insurance isn’t the primary business of a bank, you’re more likely to get straightforward answers to your questions.
Another reason to visit your bank’s insurance rep is that your bank knows the financial you – how much you have in accounts, how much comes in and goes out on a month to month basis, your tax status and other personal finance information needed to get the right kind of life insurance at the right price.
Talk to your employer. Life insurance may be a benefit along with health care and two weeks vacation, but you may also be able to increase the dollar amount of coverage with money deducted from your paycheck painlessly.
Unions, associations, your local Chamber of Commerce and other organizations are also sources for low-cost term or whole life coverage. Purchasing life insurance coverage through an industry association, for example, gets you group rates that translate into more coverage at a lower monthly premium. On the other hand, when you purchase term or whole life through your union you usually don’t have a choice of insurers and that’s an important point to consider.
Go with an insurance company that’s ranked highly by Standard and Poor or some other rating organization. Your broker or banker will steer you toward quality of coverage so you get more for your money.
Life insurance sounds complicated but, when you break it down into simple terms, it’s something you can do with a trusted advisor to point you down the right path.
Get life insurance. Get term life if you want lower premiums; get whole life if you want your insurance to build cash value against which you can take loans.