An Introduction to Life Insurance

Thanks so much for this post. I was more on the confused side of things as far as life insurance goes. This was a big help.

Great post, I have actually just begun to think about getting life insurance with my second child on the way. I hate to think of the financial burden my family will face if something ever happens to me. Good timing.

Sorry JD, but I was disappointed by this article. It really felt like an infomercial. It failed to address the single most important question of all: “How do I know if I need life insurance?”

Instead, it just said “Life insurance is great,” which is what I’d expect to hear from an insurance salesman.

I think a paragraph discussing how to determine how much life insurance you need (or if you even need it at all) was sorely needed in this post.

Incidentally, if you’re single and have don’t have any dependents or co-signers on any of your debts, you don’t need any life insurance at all. Your creditors cannot come after your family for payment if you die unless they co-signed the loans.

That was an interesting post Ray. I didn’t know about insurance, but now I have a stronger foundatin on the subject.

Keep upi the good work!

Blogging Banks

While this is a decent article, it leaves out much of the decision processing that goes on in chosing life insurance. How much should you get? What type is best now? Do you really want to make your death the lottery win for your family? etc.

Also, most insurance agents will tend to push the Whole or Universal life policies because the commisions are substantially higher, but if your goal is protection of your family during your prime earning years, you get much more bang for the buck with a term policy. For example, a $500K policy for a non-smoking, thirty year old male, may run around $45 a month (allstate) while a whole life policy for the same half million may run around $500 a month (state farm, only went to their site because I didn’t find a quick way to get a quote for anything other than term at Allstate, makes me wonder). Note if you renew the term policy at 50 and are still in reasonable health, the premiums are around $160 a month, so over 40 years of coverage (30-70) you get much more insurance if you die while paying significantly less than the whole life. That’s a big difference in the monthly budget and means if you’re looking at whole or universal life policies you are using those policies as an *investment*, with insurance benefits on the side.

While there is a place for such policies for many people in their overall portfolio, it is my opinion that most people end up being underinsured because they can only afford so much as a monthly payment since most of their “investment” money is going to IRA’s, College funds, etc. For example, if you only had $100/mo to spend on life insurance after you’ve funded retirement and the college funds, you could get a million dollar twenty year term policy, or a hundred thousand dollar whole life. The sales pitch pushes the $100K. But if you die at year 19, you get $100,000 with the whole life, but $1,000,000 with the term. If you die at year 20 plus one day, you get $100,000 with the whole life, and nothing with the term. Would it matter in 20 years? If you’re still alive will you essentially no longer need the insurance because your Roth IRA will have over $100K anyway, your kids will already have their college funds fully funded, you have no debt and the mortgage is paid off? Which is really the better deal? Which really protects your family? What are your real goals for this insurance?

If you were looking at it as an investment with insurance on the side, then you may have bumped up the amount to something more protective of your family, which is fine. But then it’s primarily an investment and needs to be looked at in that light and compared to your other investments.

Like the article said, life insurance is a tool and you need to decide how you want to use it. Check the web for some ideas of how much you should get (if you need any at all), then decide how much you have to spend and that should push your decision of term or permanent or a combination of both types. If your house doesn’t get damaged, you don’t collect on your homeowners insurance. If you don’t have any accidents you don’t collect on your auto insurance. If you don’t die, your beneficiary doesn’t collect on your life insurance. And yes, that includes the *insurance* of the whole life policy, remember, you don’t get back the insurance premiums paid. What you get back is the “investment” part.

p.s. I am not sure how some get the idea that I am an insurance salesperson, I WAS one but currently NOT involved in direct insurance sales to clients.

Interesting and very informative post.. Gives clear idea on the various types of insurance.. I have myself worked for insurance companies and out of my own experience I can tell you that other than Term Insurance, all other insurance schemes are a big scam. They just dont get you enough in return. Term insurance ic a pure insurance and is a must for every individual. So my advice would be “Buy Term and Invest The Rest” as Dave Ramsay would agree.

I found this post to be helpful because I’m not familiar with the insurance terms I’ve been reading in the financial blogs (Not sure if insurance is sold differently where I am though).

I too would like to know if I’ve got enough. I’ve got a policy through work that pays a year of my salary, but any financial calculator I’ve tried says that’s not enough. I’m single, no kids and only one debt (which is insured itself), but I’ve been thinking of getting life insurance while I’m still reasonably young and healthy.

I’m going to echo concerns of earlier posters. I really hope you’ll weigh in with a more substantive post about the pros and cons of the various types of life insurance.

Most people who know about the issue consider whole life insurance a complete scam. Period. By giving it equal billing with term life insurance, you’re implying that it’s a similarly worthwhile option. It’s not all that different from discussing types of investments, and listing “Ponzi scheme” alongside stocks, bonds, and mutual funds.

No offense intended–I’m not saying you mean to promote bad investment options. I’m just saying that this post would benefit from the same type of critical thinking we’ve come to expect from GRS.

Get off of Ray’s back. He delivered what the title described. Introduction to Life Insurance.

Your description of term insurance is a little off. The “term” in term life insurance refers to the length of time that coverage lasts. In most term products the term usually lasts until the insured reaches ages 70-100 years old. If you look on most policies it will say something like “Term to age 80″. This means that you have guaranteed coverage until that age.

The period of 5, 10, 20, etc years you describe above is the level premium period. During this time the premiums and death benefit are level. After the level period the death benefit stays the same for the length of the term, but your premiums increase a predetermined amount each year.

You can now purchase term life insurance where you get the entire premium back at the end. I think that this type should have been addressed. It is called Return of Premium (ROP). This type of insurance is sort of crossing the line of investment with term because the monthly premiums are more. Kiplinger’s did an analysis of it and determined that you would be better off investing your extra premium yourself at the end.

http://www.kiplinger.com/magazine/archives/2006/03/insurance.html

My husband and I determined that we needed enough insurance to pay off the house and have 1-2 years of salary. We got a 20 year term. Our daughter will be about 19 at that time and technically an adult. Our thinking was that in 20 years, our house would be nearly paid off and our retirement accounts would provide a sufficient buffer to help her finish up college at that time.

Wasn’t gonna comment until I saw an ad right under the article for…. insurance for your children. What’s the author’s view on that? I’ve always been skeptical from a financial perspective — and always a bit turned off on the often-emotional sales of insuring your children’s lives, even if it’s in a whole-life ‘investing in their future’ wrapper.

Also, a bit disappointed to see that no one touched on the estate planning aspects of life insurance. Since the estate tax is quite high and life insurance payouts are not considered taxable income, the benefit of having life insurance to cover your estate value, can in many ways save you from losing 35-45% of your estate to the Federal Gov’t!

This is something that I needed to read! I have been considering getting life insurance (even tho I”m still under 30) but did not know the types. This really was a good introduction. Thanks.

I have both a term and whole life policy. I figure in 20 years once the term runs out I should be okay without it. However it’s nice to know that I will have the Whole Life policy forever (in my low 30′s now). I was taking a look at my investments in the beginning of the year, and the only thing that did not lose money was my Whole Life “investment”, it actually gained because of Dividends. So ultimately the way I see it is get Term as a necessity, Whole life as a luxury/hedge investment. Thoughts?

I do employee benefits consulting work and I’m a licensed insurance agent although I do not actively sell insurance. I’ll throw in my $.02.

Need: Even if you are single and relatively young you may want to take advantage of a small cheap term policy to help pay off your funeral expenses and the costs of liquidating your stuff. Life insurance will pay a benefit faster than some of your funds may become available at the time of your death. Your loved ones will have to float the costs. Small and cheap should work. For everyone else I will echo that a term policy usually is the best.

Most of the policies described above are essentially term policies with investment vehicles attached. If you purchase a $100k policy with an investment component a portion of your premium pays the term policy (covers the $100k if you die tomorrow) and the rest goes into various investment accounts and fees to cover administrative expenses. There are exceptions to every rule but in general the only time it makes sense to purchase whole or universal policies is if you are wealthy. These policies can be used to help avoide taxes. You probably don’t need to do that unless you have maxed out your 401k and Roth IRA options and have a high annual income.

With group polies purchased through your work you may get a price break and depending on the amount you may not need to provide as extensive (or any) medical history. These policies tend to be better for older workers. The prices can often be better than in the individual market. The policies can often be rolled into personal policies if you leave the company but are generally VERY expensive when they are rolled.

Get yourself some term life coverage with some AD&D attached. If you are rich speak with your accountant.

@omar the reason the policy grew was because it is not an investment. It’s closer to a savings account earning between 1 and 4%. It wasn’t a dividend. A dividend in life insurance is a return on intentioanlly over paid premium. Does that spound fair to you?

@axe I advise against ad&d policies. Only about 2 to 5% of claims pay out because death was not caused by an accident. In otherwords, if in a car wreck, you better die at the scene BEFORE the ambulence gets there, otherwise you died due to complications and NOT the accident. A fine line forsure, but one so the company doesn’t have to pay.

@ Beagle

Thats a good point. It really depends on you personal situation and related risk tolerance. The odds are still very small that a person will contract cancer while relatively young however each person’s needs are different.

Keep in mind too that the cost of Life insurance in the group market has been fairly level. In reality it should be going down as people live longer and efficencies in administration and underwriting increase. A young person stands to get a better deal on a term policy in a few years vs. in today’s market although that value will be incremental and also relative to inflation. In other words probably too small to really make a big difference.

I suspect that many people will cut back or eliminate life insurance as savings measure during this down economy which may prompt insurers to get more agressive with pricing. Keep in mind that agressive in life insurance is only worth a fraction of a premium dollar and may not make that much of a difference to the buyer.

I think you played your cards right based on the information you had at the time (not knowing all the facts in your case).

There is a lot of talk and focus on the different types of life insurance there are and which type is best for an individual. In general (not just here), this is an over-emphasis that leads to more confusion than it is worth. Some agents I know even use the vast number of types (not all are listed here) and technical details to confuse and steer clients towards the agent’s favorite choice.

Folks should focus on their needs and the purpose behind the insurance first. Once they define that, then go shopping. This will eliminate a lot of confusion because you would only consider relevant choices and keep you from being “sold” something that doesn’t fit your needs.

Having said that, if someone will not only have an emotional loss but also a financial loss when you die, consider life insurance. There’s no right or wrong here because it is ultimately a very personal choice.

Overall, this is well written because life insurance is such a hard topic to write about. I’m speaking from experience. I was a little disappointed with the amount the word “investment” was used because cash value should not be the primary purpose of a life policy. Also, planning to access cash value down the road often ignores the risk the life insurance company poses to the owner, which is separate from any investment risk, not to mention the potential tax consequences.

@Beagle

I had something similar happen, EXCEPT I’d just gotten the insurance less than a year previous. We’d had one kid and I’d just gotten pregnant with the second, so we realized we really needed to get some life insurance. We insured ourselves appropriately, and one week after the birth of my second child I almost died of a pulmonary embolism, a blood clot in my lung (a rare complication of pregnancy). Although no underlying clotting disorders were found, I still have 20x the risk of having a second embolism, and I might not survive it if it happens again. I don’t know whether I can’t get insurance, but even if I could it would be horrendously expensive. Instead I am paying the usual premium for a healthy 20-something.

The issue I have come across many times discussing life insurance with friends is that we tend to look at a life insurance payout like a lottery win for our family after we are gone.

The part that is more difficult to understand is how the insurance company is making a profit from my premiums while still paying a large sum when I die.

Good basic info. I carried term life while I was young and raising my family. That expired and now I have only a small whole life policy that I pay into until I am 65. At that point I can just let it sit, borrow against it, or cash it out. I was maxed out on 401K’s and IRA’s so this seemed like a no brainer to me. But as a rule, term is your best bet if you want lots of coverage while raising your family.

While life insurance might have its merits, it is not something that a family revolving non-mortgage debt from month to month should invest in. Setting financial priorities is key.

@Chett (#44):

You make some good points, but I wanted to provide a counterpoint. Someone who buys a term policy at age 40 could very well need life insurance. However, as they grow older and the premiums increase, they should have less and less need for life insurance. They should have accumulated assets on their own that would enable their surviving spouse to carry on without them.

That’s one thing that’s always bothered me about the life insurance industry. If you watch a little daytime TV, you’ll eventually see commercials featuring an elderly couple discussing life insurance, and how they regret not getting any because at their age it would surely cost too much. Cue the narrator who saves the day with news that the septuagenarians can qualify for a $250,000 policy with no medical, and they’re “guaranteed not to be declined!” Personally, I find it sad that so many elderly people out there are so woefully unprepared for old age that they still need life insurance. By that age, their house should have been paid off long ago, there are no more kids on their way to college, and they’re already collecting Social Security. What possible need could they have for a quarter-million dollar life insurance policy?

Furthermore, with respect to estate taxes, if the spouse is still alive, it’s a moot point. There are no estate taxes. All of the assets simply become sole property of the surviving spouse. The surviving elderly spouse is not suddenly going to get hit with a big tax bill.

@Chett you are right. It doesn’t apply to all. Sometimes it is just invest, others it is just buy term.

You don’t work in the industry yet you are working towards (or keeping) your CFP? Hmm. That’s odd because a CFP does work in the financial services industry and is a salesman like any other agent in the industry.