Let's face it, life insurance is not exactly a topic most people are eager to discuss, but learning what it is, as well as the various options available, can make this important life decision just a little less daunting.
Let me help clarify things a bit.
Who needs it?
The purpose of life insurance is to protect those who would be affected financially by your death, such as someone who depends on you for income or care.
Some types of people don’t need any life insurance. For example, an unmarried person with no dependents doesn’t need life insurance - there is nobody who is financially inconvenienced by their passing. A young child typically does not need life insurance; although it sounds harsh, the reality is that if a dependent child dies, your future expenses are more likely to decrease rather than increase.
Some types of people may or may not need life insurance, depending on their specific situation. A married couple without dependents may or may not need life insurance - it depends on whether both spouses work, the household net worth, and the ability of each spouse to cover their future financial needs independently. A household which is financially independent may or may not need life insurance - it depends on whether additional income would be needed if one or both spouses were to pass.
Some types of people do need life insurance. Anyone who is providing care to someone else who is not financially independent (such as a child or elder) needs life insurance. Anyone whose income supports another person (such as a nonworking spouse or other family member) needs life insurance. A household which is not financially independent usually needs life insurance to cover the financial needs of a surviving spouse and/or needs of surviving children.
I prefer to use a needs analysis to determine how much life insurance you should purchase.
There are three main buckets of expenses that should be covered:
End-of-life expenses - funeral costs, etc.
Lump sum expenses - including debt payoff and future needs (such as education)
Income replacement - cover future spending needs (note that some expenses may increase, some may decrease)
Next, determine how much is already covered:
Existing life insurance policies - such as employer-provided policies
Existing assets - savings and investments can be used for lump sum payments or to generate income
Future income streams (including surviving spouse’s income and Social Security)
The difference between the two should be covered with a new life insurance policy.
In almost all cases, the most appropriate type of insurance is a “term life insurance” policy. Term insurance is much less expensive than the alternative, which is “permanent life insurance”.
With a term policy, you will need to choose the length of the policy in years - typically 10/15/20/25/30. The length of the policy should correspond to the number of years that someone is dependent on you financially, such as for income or care. You will also need to choose the “face value” of the policy, which is the amount that will be paid out by the insurance company if you die - based on the needs analysis above. The premium amount for a term life insurance policy is typically a “level premium” - so it will not increase during the time that the policy is in effect.
Insurance agents earn a large commission when they sell permanent insurance, and a significantly smaller commission when they sell term insurance. For this reason, most insurance agents will encourage permanent insurance. The nearly universal advice, by those not selling insurance, is to “buy term and invest the difference”. You will be better off.
How to buy?
I recommend getting a quote from Low Load Insurance Services. They typically have low rates for insurance products and excellent customer service. They specialize in working with fee-only financial planners and will not try to upsell you or recommend that you purchase a different product other than the one that we decide makes sense for your situation.
What if I already have a permanent insurance policy?
I recommend that you read the Financial Mentor article on Whole Life insurance. It goes into detail describing how this type of insurance works, dissecting the arguments that the insurance agents use to sell it, and going through a few case studies. Based on what I’ve said earlier, you won’t be surprised to hear that the conclusion in the end is that whole life insurance doesn't make sense for most people.
If you are convinced, then we can analyze your options (with the assistance of an insurance expert), which include cashing out the policy, rolling over to a different type of permanent insurance policy, and others. Each situation is different, so there is no “one-size-fits-all” solution.