Despite its nearly universal applicability, there's still a lot of confusion—even skepticism—about life insurance. This may be because of life insurance's complexity, the image of those who sell it, or our avoiding the topic of death.
With the proper information, you can simplify the decision-making process and arrive at the right choice for you and your family.
Here are some of the things you absolutely need to know about life insurance:
- Life insurance is a risk management tool, not an investment. There are some life insurance policies that have an investment feature, but they're not really an optimal investment. There are usually better and more efficient strategies.
- Life insurance is a valuable tool if you are someone's spouse or the parent of dependent children. If you are retired or financially independent and no one would suffer financially if you weren't around—OK, you don't need life insurance.
- Don’t just slap a monetary value on your life. Rather, it helps compensate for the financial consequences that accompany the loss of a wage earner's life. It can help those left behind cover the costs of final expenses, outstanding debts and lost income. After an unexpected death, life insurance can lessen financial burdens at a time when surviving family members are dealing with great loss. It can also give peace of mind to the policy holder.
There are two kinds of life insurance—term and permanent, also known as whole life insurance. Term life is the simplest, the least expensive, and the most widely applicable. The life insurance company bases the policy premium on the probability that the insured will die within a stated term—typically 10, 20 or 30 years. The premiums are guaranteed for the length of the term, then the policy becomes cost-prohibitive to maintain—or you can decide to let it lapse. This means that you could pay premiums for decades and "get nothing out of it." That's good news because it means you were protected during that time.
Permanent life insurance includes the same probability-of-death calculations but also includes a savings mechanism, often referred to as "cash value." It's designed to help the policy exist into perpetuity. Whole life has an investment component, and variable life has investment options more like mutual funds. Universal life is a less expensive permanent life insurance alternative with added flexibility but increased interest rate risk for the owner.
"Life insurance is… deserving of consideration by every household." It's better to set up something you can work with and understand than to postpone such an important decision due to the policy's intimidating complexity. In many circumstance, a good rule of thumb is to purchase enough life insurance to replicate all or most of the insured's income for a term as long as the household expects to need that income.
Open and honest discussions about planning for an unexpected death can be surprisingly life-giving and purchasing life insurance is an important part of your long-term and comprehensive financial plan.
Reference: Forbes (January 5, 2016) "10 Things You Absolutely Need To Know About Life Insurance"