There are many varieties of life insurance available in the marketplace; certain kinds of policies are not always appropriate for certain people in their own individual circumstances. To make matters worse, insurance policies are usually sold by brokers working for commissions, who often peddle inappropriate insurance products without objectively assessing a customer’s needs. You need to do independent research, or work with a financial advisor, to ensure that you’re covered adequately in a manner that makes sense for your situation.
The most basic kind of life insurance is called “term life insurance”; these policies are very simple. Essentially, you purchase a term policy that promises to pay a certain amount of money, known as a “death benefit,” to your beneficiary when you die. To secure this benefit, you must pay premiums periodically over a set “term” of, say, 30 years. If the term expires without your dying in the meantime, the policy also expires, but can be renewed if desired (though premium payments for a renewed policy will undoubtedly be higher). If you die while the policy is in effect, the death payment will be made to your beneficiary, and that also ends the policy; no more premium payments are required. Term policies have no cash value, or any value at all apart from the death benefit.
Term life insurance serves one principle purpose: to replace income that would be lost should the insured die, and thus prevent financial hardship for surviving dependents. Although circumstances vary, a common benchmark specifies that a death benefit should be a sum representing six to eight years of the insured’s income. Of course, if your spouse also works and has good income, or if your family has other sources of income, you may not need to provide such a generous benefit, especially if making the premium payments is burdensome. And if you don’t work at all — if you’re a nonworking spouse or retired — then in most cases you don’t need life insurance. You have no income to replace, and your surviving family members will get along just fine, financially at least.
Some people have argued that even nonworking persons need some life insurance, to help their survivors pay off funeral expenses. Unless you’re planning a major event to kick off your afterlife, this is bogus advice. Instead, regularly deposit some funds in a designated account until you have the few thousand dollars you’ll need for funeral expenses, then put the sum in escrow such that the executor of your will, for instance, can access it when the time comes.
There are indeed legitimate purposes other than income replacement to purchase a term policy. If you have negative income — i.e., transferrable debts — a death benefit can help your heirs pay off those debts. If you have a family business that you’d like to pass on to heirs but calculate that inheritance taxes on the business will be prohibitively expensive, forcing your heirs to liquidate the business, then a death benefit can be earmarked for such taxes. Of course, your heirs can choose to pocket the cash from the insurance payout and liquidate the business anyway, but at least they’ll have the choice. Or you may simply wish to leave your survivors with a nest egg. In any case, you’ll need to do a cost/benefit analysis: is the benefit worth the cost of the premiums?
Retirees face some particular choices with regard to term life policies. Once you’ve retired, you and your spouse may then begin living on investment income and Social Security. This kind of income, if set up properly, will not be affected by your death; your spouse will continue to receive the same level of income, or close to it. With no income to be lost by your death, in most cases you no longer need term insurance, and can allow a policy to lapse, saving yourself the cost of the premiums.
In another scenario, you may be receiving a fixed-income pension from your company or from the government, if you were a government employee. Such pensions generally incorporate what’s known as a “survivor benefit.” You will receive a certain fixed payment each month, meant to cover living expenses for you and your spouse, as per the terms of the pension. If you should die first, your spouse will continue to receive payments for the remainder of his or her life, but at a reduced amount. In such a case, you can continue to maintain a term insurance policy, meant to make up the difference in income between the full pension payment and the survivor benefit payment. However, bear in mind that, after you die, there will be one less mouth to feed, and your spouse can likely maintain the same standard of living on less money. Again, you’ll need to do a cost/benefit analysis.
Buying Tips for Term Life Insurance
Term policies can be purchased from any number of insurance companies; be sure to purchase from a reliable and longstanding company that is not at risk of defaulting. Be careful in making this selection, and pay attention to the word “longstanding”: you may need to rely on the company to make a payout 30 years in the future. The company will have to determine your insurability, which largely consists of checking medical records. If you have a terminal illness, you will not be insured.
The most common form of policy is a guaranteed level premium policy. Under such a policy, your premium payments are guaranteed at a certain level for a given period of years — commonly 10, 15, 20, or 30 years. Such policies are often renewable; premiums will go up during the renewal period, but often the increases are capped. The policyholder may or may not be guaranteed a renewal offer; be sure to check whether further proof of insurability is required for the renewal period. You have no idea what your health will be like in 30 years. If there are no guarantees in this regard, then you may wish to purchase a policy for the longest term possible, that takes you well beyond your anticipated retirement date.
To determine the cost of premiums, insurance companies refer to mortality tables, often called actuarial tables. These tables calculate the probability of dying for persons of different ages; the math can get complex. Premium costs vary on circumstances, but a healthy 40-year-old man purchasing a 20-year level premium policy (i.e., with a fixed annual premium for 20 years) might pay around $350 a year for a $500,000 death benefit. A 50-year-old man purchasing the same policy might pay three times as much. The younger and healthier you are, the cheaper your policy will be. Another reason to quit smoking!
If your dependents would be burdened financially by your premature death, then you need life insurance. And most financial advisors recommend a simple term policy to provide that coverage. These policies are not expensive; start looking now, and provide some peace of mind to your family.