Life Insurance 101

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Death isn't always easy to talk about and a subject that most people avoid as long as possible. But when it comes down to insuring your family in the event something happens to you, it pays to take a serious look at life insurance and how it can work in your favor.

Additionally, the sooner you begin looking at your potential life insurance options, the better. Every day you wait makes your life insurance premiums more expensive (based on your age) and opens up the possibility that you could become sick and possibly uninsurable. 

Why Would You Want Life Insurance?

When you pass away, life insurance covers lost income so your loved ones aren't burdened with having to replace your economic value. That's not to say that a life insurance policy will cover everything you need into perpetuity, it usually doesn't. It will all depend on the amount the policy was written for when it was taken out. Your insurance agent should help you calculate how much death benefit you will need to comfortably cover your family's expenses for a reasonable period of time. But as a general rule, LifeInsure.com recommends the following coverage guidelines:

Age of PolicyholderRecommended Death Benefit
25 years old25x annual income
35 years old20x annual income
45 years old15x annual income
55 years old10x annual income + any estate tax liability

Basics Types of Life Insurance

Whole life

Whole life (also called permanent coverage) is just that, insurance protection that does not expire. It has both a death benefit component and an investment component as part of each policy. The premiums you pay into whole life accrue over time and build cash value that you can borrow against. Because of this, premiums on whole life are significantly costlier than what you'll find with term life insurance (discussed below). If you happen to borrow money from the cash value of your life insurance policy, you can often do so without penalty. Also, the loan you take out doesn't need to be repaid and will simply be deducted from the eventual death benefit. 

Universal Life

Universal life insurance is a more flexible version of whole life. It allows its policyholder to make variable premium payments (whole life premiums are consistent) from month to month. Universal life also gives you the ability to increase the face value of your policy at any time. However, you'll need to undergo another medical exam before the increased policy coverage is approved.  

If you're ever to get into financial trouble, universal life affords you the option to stop paying your premiums and use the cash value of your policy to cover that cost. This built in flexibility has made it a popular choice amongst consumers. Be careful though, if you're not paying your premiums and assuming the cash value has got you covered, you'll want to make sure to have sufficient funds so your policy doesn't lapse in coverage.

Variable Life

Variable life (VUL) policies have the same payment flexibility that you find with universal life. The primary difference between VUL insurance and other permanent insurances is the ability for the policyholder to choose where their money is being invested. A large portion of your premiums payments will be invested in the insurance company's investment fund in whatever asset class you prefer (stocks, bonds, mutual funds, money market funds, etc.) Over time, this has the chance to generate a much larger cash value in your insurance account than a traditional whole life policy does. Conversely, if your more aggressive investment strategy performs poorly, you could potentially be left with a significantly lower cash value and death benefit than was anticipated.

Term life

Term life insurance, unlike whole life, only has a death benefit. This means it will pay out the face amount of the policy at the insured's time of death. It's also different from whole life insurance in that it protects you for a defined and limited amount of time, which is specified in your policy. There's no investment or cash accrual component to term life either. Because of that it's much cheaper to purchase a sizable policy for a fraction of the whole life insurance price. 

What We Think

For the vast majority of people in the market for life insurance, a cheap term insurance policy is going to do the trick. You can purchase a sizable death benefit for a fraction of the cost versus a whole life policy. We think that the "forced savings" insurance companies so often sell as a core benefit of whole life can be allocated more wisely, into an annuity for example, where the fees and commissions are lower. And if your goal is longer term savings, the slower cash accumulation in whole-life policies make annuities the savvier choice of the two.

There are exceptions to our recommendation, however. It can still be financially prudent for very wealthy people to allocate money into whole life insurance. This is normally done as part of a broader estate planning strategy which intends to supply their heirs with cash to pay off estate taxes. When a wealthy family member dies it often puts the beneficiaries of the estate in a bind, causing a need for cash as the IRS comes to collect their piece of the pie. Instead of having to liquidate a large percentage of the inherited investments (such as stocks, real estate, or even a family business) the cash built up from the whole life insurance policy can be used to pay the estate taxes while keeping investments intact.

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