Life teaches us that we can never be too prepared. We all need a protection plan in place, which includes a few essential elements: An emergency fund, health insurance, a basic estate plan and – for many of us – enough life insurance.
Unfortunately, life insurance is something many people avoid thinking about for as long as possible. Others don’t prioritize it because they’re not sure if they need it. In reality, the question of whether or not you need life insurance is an easy one to answer. Ask yourself: Would anyone suffer financially if you weren’t around to provide for them? This could be a child, a dependent parent, a spouse, or even a business partner.
If your answer is yes, then it’s time to consider buying some type of life insurance, which would provide your beneficiaries with funds (known as a “death benefit”) if you were to die. Your death benefit could help replace your income, cover funeral costs, pay off debt, or fund college for your kids, among other things. Simply put: Life insurance is a smart, often cost-efficient way to make sure others are taken care of if something were to happen to you. Here’s a guide to help you figure out which type of insurance makes the most sense for your needs.
Term Life Insurance
Term life insurance provides a death benefit for a specific period of time called the term. When that period is over the coverage terminates. Term is a pure insurance policy with no investment component attached, which is why it’s usually the most inexpensive form of life insurance. The cost varies based on the size of the death benefit, your health and your age. As you get older (and are more likely to die) the cost of a term policy goes up. That’s one reason many people opt for “level term” policies, which hold your premiums steady for up to 20 or 30 years — another reason is that with these longer-term policies you don’t have to go through an underwriting physical to qualify each time you renew. The other option would be “renewable term” policies, where your premiums can go up every year. But those can require new physicals, and if your health is declining, you could be looking at a much bigger bill.
Term life insurance is the right insurance for most people — because it’s the best way to get the most amount of coverage for the least amount of money. For many people, it’s the only way to afford the total coverage you ideally need. It also works well for anyone who needs coverage for a limited amount of time. For example, you might need coverage until your child graduates from college or until your mortgage is paid off. If you die during the term of your policy, your designated beneficiary will collect the death benefit. If not, your policy will end once the term is over. (Note: It’s always a good idea to make sure your term is “convertible” to permanent insurance. It won’t be free, but if you do need the coverage for a longer period of time, you know you’ll be able to qualify for it even if your health has declined.)
Employer-Sponsored Term Life Insurance
Many of us have some group term life insurance coverage available through our employers, and in many cases we might not even realize it. Check with your HR department to understand what’s available to you. Buying a policy through your employer may offer a less expensive way to buy more, because group life insurance policies — like group health insurance policies — spread out the risk the insurer is taking over a larger group of people. The downside is that when you leave your job you’ll lose the coverage unless you can arrange with your employer to continue it by paying out of pocket (not all employer policies are “portable” in this way, but some are, so ask.)
Accidental death and dismemberment insurance (also known as AD&D) is another common form of employer-sponsored life insurance. And while this can be a great safety net to have, it won’t pay out a death benefit if you pass away from illness or other non-accidental causes. If this is all your employer offers, shop for additional insurance on your own.
Permanent Life Insurance
Permanent life insurance provides coverage for as long as you live providing the premiums are paid. Besides including a death benefit, permanent insurance has an investment component that enables you to accumulate cash value.
How does that work? A portion of your premium goes toward building a cash account which can then grow tax-deferred from policy dividends, interest or investment earnings. And depending on the policy, you can borrow against it, or withdraw cash value. But because it’s doing double duty by providing an investment vehicle and a death benefit, permanent insurance typically costs more than term. Often much more. Also, any loans or withdrawals that aren’t paid back into the policy can reduce the death benefit, possibly leaving your loved ones with less.
Ultimately, to determine if permanent life insurance is right for you, you’ll need to ask yourself a couple of questions. First, what can you afford? If buying term is the only way to get enough insurance to provide for the needs of your dependents, then term is the way to go — or at least the way to start. Again, you can often add some permanent insurance down the road by converting term life into permanent.
Second, do you see yourself needing life insurance when you are 70, 80 or older? If your kids are self-sufficient and your spouse will be fine living on a combination of savings, investments and Social Security, then you may not need permanent insurance. But if you have a special needs child who will require your support well into adulthood, at least some permanent insurance is often a smart move. It can also be worth considering if you want to have enough insurance to cover estate taxes when you die.
Which Type of Permanent Life Insurance is Right For You?
There are three major types: whole, variable and universal. Here’s a rundown on each.
Whole life insurance (sometimes also called “straight life” or “ordinary life”) typically remains in effect for your entire lifetime as long as you pay all required premiums. You’re guaranteed a certain death benefit and rate of return on your cash value, which comes from the premiums you’ve paid and the interest those premiums accrued. It’s a good solution for people looking for insurance for life without any surprises.
Variable life insurance provides a death benefit and cash value that rises and falls with the performance of underlying investments. You choose how to invest your premiums (typically in a menu of mutual funds) and you (not the insurance company) assume some of the risk. It’s ideal if you are willing to take on some risk to see the cash value grow.
Universal life insurance is the most flexible permanent life insurance option. It has adjustable premiums, meaning you’ll have the option to pay more or less as long as you’re maintaining the cost of the insurance. You can put more money into your policy if you want to grow its cash value. You can also adjust how much of your premium goes toward the cash value (versus paying the premiums) and then choose how it’s invested. You also have the option to pay your premiums with the cash value that builds up. So instead of writing a check to your insurance company every year, you can draw down the cash value to pay the premiums and maintain your policy. The policy is self-sustaining unless the cash value runs out.
If you’re thinking about permanent life insurance as a way to build cash reserves, weigh the risks and costs with the potential for growth. You should also talk with a professional who can explain the return you can expect to see before you buy. And if you don’t understand exactly what you’re looking at? Keep asking questions until you do.
