Understanding and Controlling Your Finances:Life Insurance

Life insurance is a form of insurance that pays out when someone dies. Life insurance is a funny thing for three reasons:

1. You are never going to use a life insurance policy that you buy on your own life. After all, you will be dead when the policy pays out. Life insurance is therefore a gift that you give to someone else.
2. The chances of you dying "before your time" (say, before age 70) are pretty slim in this day and age. Therefore, the chances of a life insurance policy ever paying out at a time when it is really needed (for example, at age forty when you have a spouse and two teenage daughters depending on your income) are slim as well.
3. However, it is guaranteed that you will die at some point, and there is a fair amount of emotion around this particular fact of life.

These three facts make life insurance work like no other insurance policy ever will. The emotional component attached to death is, in and of itself, enough the alter the entire sales process and the types of conversation that happen during the sale.

Compare life insurance to an automobile insurance policy, for example. If you wreck your car the insurance policy pays you a check, so you get a direct benefit from the policy. The chances of you being in a wreck are pretty good - you see wrecks every day. Finally, if you wreck your car it is not the end of the world. You will simply go buy another one. Automobile insurance is therefore a commodity item that you purchase without emotion - you have to have it, so you buy it at the cheapest price you can find.

Not so with life insurance. If you do not know what life insurance is and why you do or do not need it, there are two things that can happen should a life insurance salesman happen to call:

1. You can be "guilted" in to purchasing insurance that you do not need.
2. You can be sold other components that are ancillary to life insurance at inflated prices.

The following sections therefore give you a brief introduction to life insurance and how to purchase it rationally.

What is Life Insurance?

As mentioned at the beginning of the article, life insurance is a form of insurance that pays a beneficiary in the event of someone's demise. You purchase a specific death benefit when you purchase the policy. You might buy a $100,000 life insurance policy, for example. You then assign that $100,000 benefit to a specific beneficiary, like your spouse. Should you die during the term of the insurance, then your spouse will receive $100,000. It is as simple as that.

Types of Life Insurance

There are two types of life insurance: 1) Term life insurance, and 2) everything else. Term life insurance is pure, unadulterated life insurance. "Everything else" is term life insurance bonded to some sort of savings component. It is called various things by various companies: "whole life", "universal life", and so on. Click here if you are interested in more specific descriptions of the different types of life insurance.

Let's say that you would like to buy $100,000 worth of life insurance. If you bought that as a term policy you might pay $15 per month. If you bought it as whole life, you might pay $100 per month. Depending on the company selling the policy, you will then be assured that the difference ($85 per month) will act as an investment that will "pay off the life insurance" and/or pay you a cash value at age 65.

The problem with everything besides term insurance is that the savings part is inefficient. Also, it is only as secure as the company issuing the policy. You would be much better off simply depositing the $85 in a stock mutual fund each month (as described in the article entitled "Investment Options"). You would, over time, make much more money that way.

There is now also a growing "mini-life" industry. This industry tries to attach special purpose life insurance policies to car loans, mortgages, etc. These too are totally inefficient. If you feel that insurance to cover your mortgage is important then comparison shop a normal term policy of the same value against the policy being offered by the mortgage company. You will be amazed at the price difference. Never buy mini-life policies until you comparison shop.

Who Needs Life Insurance?

Some people truly need life insurance. For others it is a waste of money. Let's look at some scenarios to see who does and does not need a policy.

Let's say that you are a single man or woman living alone in an apartment. Do you need life insurance? No. Who, exactly, would be the beneficiary? There is no one in your life who is dependent on your income. The only reason you might buy life insurance is the same reason you would buy a lottery ticket - you might win. You might, after all, die young. And if you had a life insurance policy and you did die young you could make someone very happy. Or you might buy a small policy to pay your funeral expenses at death. In that case $10,000 is all that you would need, and that would be one nice funeral. There are probably better things to do with your money while you are alive.

Let's say that you are a single man or woman living alone in a house with a $100,000 mortgage. Do you need life insurance? Maybe. The reason you might buy life insurance is to save your parents (or whomever else you have willed the house to) the problem of disposing of your estate. For example, imagine that you die. Your parents (or whomever) inherits the house. Now they want to dispose of the house, but it sits on the market for two years before selling. During that time they are having to pay the mortgage payments, and that might be a hardship. Therefore you might buy a policy to cover the expected payments over (for example) two years, or the entire mortgage.

Let's say that you are a married man or woman living alone in an apartment or a house. Do you need life insurance? If your spouse does not work and you want to provide for your spouse should you die, then yes. If your spouse does work but could not possibly support his or her current lifestyle should you die (for example, could not possibly pay the house payments), then yes. Otherwise, probably not. Having life insurance would be a nice remembrance if you were to die, but it is not essential.

What if you have kids and you provide income that they depend on? Then almost certainly, unless you are rich enough to be "self insured", you need life insurance. Yes yes yes. You need enough coverage to allow your spouse and children to live a comfortable life in the absence of your income.