What is Life Insurance
Life insurance is a contract with an insurance company where you make payments over a period of time. In return, the insurance company provides money to your family after you die.
It’s a way to ensure the financial security of your family after your death. Like all other types of insurance, it is a financial tool used to minimize a specific risk—the risk that your family will be left in poverty if you die and are unable to provide for them.
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- Insured—the person who takes out the insurance policy
- Death Benefit—the amount of money the insurance company will pay in the event of the insured’s untimely death
- Designated Beneficiary—the person who will benefit from the payout, normally the insured’s spouse or children
- Premium—the amount of money that the insured pays monthly to secure a policy
Many different forms of life insurance are available. In general, these can be divided into four categories: Whole Life, Universal Life, Variable Life and Term Life.
Life Insurance Options
|Whole Life - Permanent||Universal Life||Variable Life||Term Life|
|Coverage Period||Life of Insured||Life of Insured||Life of Insured||Specified Period, Max 30 Years|
|Guaranteed Death Benefit?||Yes||Yes||Yes||Yes, If Insured Passes During Policy Term|
|Secondary Benefit?||Interest-Earning Cash Account, Tax Deferred||Interest-Earning Cash Account, Tax Deferred||Investment Account; May Include Bond, Money Market, or Equity Funds||No|
|Secondary Benefit Amount||Fixed Interest Rate Guaranteed||Changeable Based on Premiums, Interest Rate Not Guaranteed||Investment Account Value is Variable Due to Market Changes, Rate of Return Not Guaranteed||N/A|
|Flexibility||Fixed Premiums and Benefits||Flexible Premiums, Death Benefit, and Cash Investment at Insured’s Discretion||Flexible Premiums, Death Benefits, and Investment Contributions at Insured’s Discretion||Fixed Premium, Benefits, and Term. Some Policies May Be Extended or Renewed.|
|Cost||Most Expensive||Less Expensive than Variable Life||Less Expensive than Whole Life||Least Expensive|
Term Life vs Universal Life
One key difference between term life and universal life insurance is that term life is temporary and universal is permanent.
|Term Life||Universal Life|
|Provides a Guaranteed Death Benefit||✓||✓|
|Focuses on Affordability||✓|
|Can Provide Coverage for Your Lifetime||✓|
|Covers Two Lives with One Policy|
|Has the Potential to Build Cash Value||✓|
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Do You Need Life Insurance?
Contrary to popular belief, not everyone needs life insurance. If you’re young and don’t have any dependents, you may not need it. However, if you plan on having dependents, it’s a good idea to buy insurance when you’re young to guarantee your insurability. You may also not need life insurance if you’re older with no dependents and have saved enough to provide for yourself and your partner.
How Much Do You Need?
Income Replacement Approach
One way to estimate how much life insurance you need is by calculating the replacement income needed. This takes into consideration your age and your earnings; you start with your age and figure out how many years of income you’d need to replace if you died. It often takes into account income tax as well as inflation. A problem with the income replacement approach is that it’s not very individualized.
Another way to calculate how much life insurance you need is through the needs-based approach. This is based on replacing the amount your surviving family will need to maintain a certain level of income and lifestyle. Factors include whether your partner will continue or start to work, how many children you have and the cost of educating them, and whether or not you have a mortgage. Although more accurate, the needs-based approach will take more time and reflection to perfect.
- 41% of the U.S. population doesn’t have life insurance.
- 93% of Americans say that life insurance is something most people need.
- Life insurers pay out $1.5 billion every day.