Some of you may wonder “What in the world does life insurance got to do with my personal finances?”
The truth is that it plays a more significant role in your money than you think for 2 reasons:
1) Life Insurance is about taking care of those you leave behind. Do you have a spouse? Children? Dependents? If something were to happen to you, who would take of the bills? Pay the mortgage so they can stay in their house? Pay for your kids’ college? Life insurance is part of your safety net for protecting those you love.
2) Choose poorly and you can significantly over-pay! There are thousands of life insurance products available, and the costs can vary dramatically. If you learn about what the differences are, then you can select the most economic option for your situation and not drain your budget. Note: I made this mistake, so read on to learn how to avoid this situation.
To begin, let’s start by understanding the differences between the available life insurance products. At first glance, there is a lot of confusion and complication – precisely the reason most people put off getting life insurance in the first place. But once you dig into it, you’ll find it is easier to understand than it appears.
Basically, all life insurance can basically be broken up into two broad categories.
Obviously, the cost of the insurance is dependent upon 1) the amount of money you wish to receive upon death (called the death benefit), 2) your health, and 3) which type of product you choose.
Generally the death benefit should be somewhere between 10 to 12 times what you’re currently earning. The idea is that if you were to pass away, your spouse would still receive the equivalent of 10 to 12 years worth of your “working” income (Note: This definition will be important later on).
Term Life Insurance:
Term life insurance is the cheapest and easiest product to buy. Do you have car insurance? Buying term life insurance is basically the same thing. You send in your payment and in return you get coverage. When you stop paying, you stop getting coverage. It’s that simple.
However, unlike your car insurance, term life insurance is only good for a set amount of time, usually between 5 and 30 years (hence the name “term”). Once the term expires, you have to re-apply for the insurance (usually by passing another medical exam). Also, the cost starts to go up – a lot! This is because as you get older, your medical situation changes, and thus you become a higher risk for the insurance company.
Permanent Life Insurance:
The easiest way to think of permanent life insurance is to take my description of term and add a small investment account with it. Basically with permanent life insurance, you pay significantly higher monthly premiums (a lot more than with term) to the insurance company. They put this money into an investment account (that they fully control) and your life insurance fees are deducted from it (along with the insurance company’s administrative fees). Anything that is left over is yours to keep (called your cash value).
Why would such a product be offered? Because “in theory” that account you’re putting together should grow so large that it eventually pays for all your ever-increasing life insurance fees (Remember: As you get older, the insurance company charges more to cover you). In theory ….
The other big benefit: You’re guaranteed coverage for life. For example, you could start in your 20’s or 30’s when you’re young and healthy and still have coverage into your older age even after you’ve began to experience health problems. The only trick – you have to never miss a payment, which means that that investment account can never drop too low.
The most common types of permanent coverage are:
• Whole Life Insurance – This is by far the most expensive. But it also guarantees that you will never run out of money in your investment account because your money will be invested conservatively.
• Universal or Variable Life Insurance – These types are a little bit cheaper than whole life. The reason is because they use a more risky investment strategy than Whole Life to go after higher returns. Although this sounds good, remember that more risk means your account could drop to zero. If that happens, you may be asked to kick in extra money to bring up the difference.
The Deal Breaker:
I was a Permanent – Variable Life Insurance policy holder for a long time. I was paying approximately $117 per month for a $500,000 policy whereas I could have paid $18 per month for a 10-year Term Life Policy. At the time, I chose the Variable policy because it wasn’t too expensive (compared to the Whole Life), I liked the prospect of guaranteed coverage for life, and the thought of building some type of investment cash value on the side sounded great.
That was until one day I read something that was a total game changer…
Click here to continue to Part 2 of this series where we’ll thoroughly examine two real prices I was quoted for Term and Variable Life Insurance and conclude which one was the better deal!
Photo Credit: Microsoft Clip Art