Understanding and Evaluating Life Insurance
Life insurance should help protect those that financially 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.
1. Do you need life insurance?
Life insurance should provide financial protection for your loved ones in case you die. If you do not have a 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 for.
2. If life insurance is needed, how much?
The answer to this question is not always simple. The fundamental rule is that life insurance proceeds should allow your loved ones to have the same financial lifestyle they would have experienced if you were still living.
Some say 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 view 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
- Investments or other income
- Life expectancies
- Special needs for college, etc.
There are many books and resources available at libraries, online, or from financial advisors that can help you compose a more accurate estimate. It is probably more appropriate to err on the high side rather than leave your family under-protected.
3. What type of policy is best for you?
There are two primary types of life insurance policies – term and cash value whole life. Their costs are dramatically different.
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 when taken out at younger ages. Term policies provide protection for a specific number of years. When that term concludes, the insurance ends. That is why it is logical to obtain the longest term possible.
Cash value whole life insurance
Many insurance agents urge their customers to purchase 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 are tax-deferred, and you can usually borrow against it if you need money. These policies are also typically permanent. In other words, once you buy them and continue to make the premiums, they remain in existence.
The core 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 often 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 increase of the "savings" account portion of the cash value policy.
Another issue to consider
There may be more economical sources of life insurance available than what you would perhaps come across browsing 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 to their members. They are often able to negotiate very favorable rates. You should check out these types of sources as well.