Understanding and Evaluating Life Insurance
Life insurance is really very simple. If you die, it pays off. Its purpose is also
simple; it should protect those that rely on you. It should not be viewed as an investment.
It is easy to get confused about this emotional issue. But really there are only three
questions you need to answer.
Do you need life insurance?
Life insurance should provide financial protection for your loved ones in case you die. If
you have no spouse or children, life insurance may be unnecessary. If you are married and
your spouse can handle living expenses without you, it may be unnecessary. However, if you
have loved ones that need the financial support you provide and will provide in the future,
you should consider life insurance to make sure they will be adequately protected and cared
If life insurance is needed, how much?
The answer to this question is not always simple. The basic rule is that life insurance
proceeds should allow your loved ones to have the same financial lifestyle they would have
had if you were still living.
One rule of thumb is that you should have a policy that would pay six to eight times your
pretax income if you die. But, many find they need more than that. If you have young
children and want them to be able to afford college educations, you may want more. If you
are older and already have accumulated substantial wealth, you may want less and see life
insurance as part of a total estate plan.
A more detailed determination of the amount of life insurance you need should take into
account the following items:
- Your family's cost of living
- Income from earnings of the surviving spouse
- Benefits from Social Security
- Investment or income
- Life expectancies
- Special needs for college, etc.
There are many books and resources available at libraries, on the Internet or from
financial advisors that can help you make a more accurate estimate. It is probably to err on
the high side rather than leaving your family under protected.
What type of policy is best for you?
There are two basic types of life insurance policies - term and cash value whole life. Their
costs are dramatically different.
Comparing annual premiums for $100,000 of coverage
Cash value whole life
The most basic form is called term life insurance. Term life insurance is pure protection.
Its only purpose is to pay your beneficiary if you die. It is generally much cheaper,
especially at younger ages. But the cost of term insurance goes up as you get older. Term
policies provide protection for a specific number of years. When that term runs out, you
will need to apply for another policy. That is why it makes sense to get as long as term as
Cash value whole life insurance
Most insurance agents urge their customers to buy the more expensive cash value type of life
insurance. These policies provide death benefits and also enable the policyholder to build
up a "cash value" that acts as a savings account. The earnings on this "savings" account is
tax-deferred and you can usually borrow against it if you need money. These policies are
also generally permanent. In other words, once you buy them and continue to make the
premiums they remain in existence. Many of them also allow you to continue to have
protection after paying for a number of years.
The real issue with cash value policies is that they are expensive. Usually there is a
large commission paid to the agent and the earnings rate on the "savings" account portion is
usually relatively low. You may want to do a calculation that compares the two. Assume you
can invest the difference between the two premiums and compare what that grows to with the
build up of the "savings" account portion of the cash value policy.
Another issue to consider
There may be sources of life insurance available that are cheaper than what you would find
shopping on your own. Many employers offer group term insurance as part of their employee
benefit program. There are also many organizations that provide special group life insurance
programs for their members. Professional organizations, like accountants, attorneys and
medical professions have programs specifically tailored for their members. They are often
able to negotiate very favorable rates. You should check out these types of sources.