Life Insurance

How To Choose Life Insurance

By David Krug David Krug is the CEO & President of Bankovia. He's a lifelong expat who has lived in the Philippines, Mexico, Thailand, and Colombia. When he's not reading about cryptocurrencies, he's researching the latest personal finance software. 8 minute read

The widespread misconception that most individuals do not require life insurance is among the most harmful misunderstandings surrounding this topic.

Reason being, the reality is more like the contrary. Even those who do not have any financial obligations or dependents are strongly encouraged to purchase life insurance.

Those who are too busy to look around for the finest life insurance coverage could find solace in the common belief that it is not always necessary to purchase protection against the unthinkable. Reframing a task as unnecessary makes putting it off that much simpler.

Understanding the Various Kinds of Life Insurance Policies

Therein lies the confluence of two persistent myths about life insurance: the widespread misunderstanding that coverage is mandatory, and the widespread assumption that acquiring coverage is an arduous and time-consuming process.

That’s not the case. Everyone agrees that looking for life insurance isn’t exactly a joyful activity, but thankfully, it’s not usually a nightmare either. And it’s far less of a hassle if the person shopping for life insurance already knows what they need.

Two types of life insurance exist: term and permanent. The death benefits received by policy heirs are tax-free in both cases. Policyholders of term life insurance typically have the option to renew their coverage year after the first term ends.

Low-friction providers like Haven Life, Bestow, and Ladder are among the top life insurance companies that also provide affordable term life plans, as do the other insurers on our list.

Unlike term plans, the cash value in a permanent life insurance policy grows tax-free over time. Permanent insurance have far higher premiums than term policies since they cover the insured for his or her whole lifetime until the policy is terminated or cashed out.

Life Insurance (Term)

A term life insurance policy’s premiums and death benefit are always set in stone from the outset. The most usual durations of a term are 10, 15, 20, and 30 years.

The premiums for an insurance are guaranteed to remain the same for the duration of the original term, but they may increase significantly if the policyholder decides to renew for further annual periods. There are a number of reasons why term life insurance is a better option than permanent life insurance for many customers.

To start, the rates for term life insurance are significantly lower than those for permanent life insurance, often by as much as 90%. In turn, this frees up policyholders’ cash flow and allows them to put their money into market-traded assets, which may provide better long-term returns than permanent life insurance.

If you’re young and in good health, purchasing a term life insurance coverage will be a wise financial decision. Therefore, it is preferable to get life insurance from an early age, even if important life events like moving into a larger home or having more children are still in the future.

Due to its modest premiums, term life insurance allows policyholders with limited financial resources to secure adequate protection. That’s crucial for those who have a lot of debt relative to their income or who anticipate having hefty outlays in the future, like paying for college for several kids.

And when policyholders realize more of their projected lifetime earnings, pay down debt, and raise their net worth, their need for life insurance often decreases.

Consequently, the transient nature of term life is frequently a feature rather than a drawback. If you’ve done your homework, you won’t need insurance once the original term of your policy has ended.

Permanent Life Insurance

Permanent life insurance, often called cash-value life insurance, is coverage that lasts for the rest of your life and builds cash value.

When the cash value of a permanent life insurance policy reaches a certain point, the policyholder has the option of withdrawing the funds, taking out a loan against the amount, using the cash value to pay premiums, or surrendering the policy in exchange for a lump payment.

The monetary worth of a policy, less any surrender fees or penalties imposed by the insurance company, is known as the surrender value.

Compared to term life insurance, permanent insurance might be difficult to understand. Common forms of permanent life insurance include whole life, universal life, variable life, and variable universal life policies. On a scale of danger and adaptability, each variety falls somewhere unique:

  • Whole life insurance is the safest and most stable option, since its premiums are locked in and its cash value grows steadily over time.
  • As a result of universal life’s premium-freeze and -resume features, it’s a good choice for those who need financial flexibility but are concerned about the unpredictability of the policy’s death benefit during times of transition or financial distress.
  • Variable and universal life insurance provide premium flexibility but also premium risk by having cash value tied to market-traded securities.

One major advantage shared by all permanent life insurance plans is the certainty of being covered no matter how old the policyholder may be. Policyholders pay a literal premium for long-term protection, despite more flexibility in some insurance types.

Depending on the age and health of the policyholder, the duration of the comparable term policy, and the kind of permanent policy, the premiums can be five to ten times more than those for term life insurance plans with the same death benefit.

There are also a number of significant downsides to having permanent life insurance. Permanent life insurance plans are not a good long-term investment compared to diversified equities investments.

The cash value of permanent plans is based on market-traded investments, and these investments often have higher commissions and costs than do low-cost mutual funds and ETFs.

Furthermore, surrender charges often apply to permanent plans that are paid out during the first 10–15 years, significantly reducing the cash value payment. The financial value is usually completely nullified by surrender costs in the first five years.

Many potential policyholders should avoid purchasing permanent life insurance due to the aforementioned drawbacks. Permanent insurance may seem like a good investment because of its tax-free benefits and peace of mind, but this is not always the case.

Some people may be better served by a long-term financial strategy that includes both sufficient term life insurance and regular contributions to tax-advantaged investment accounts like IRAs and 401(k)s. However, if the financial option you’re considering may have lasting effects, you should talk to a financial counselor beforehand.

Determine and Calculate Your Life Insurance Requirements

After settling on a policy type, it’s important to evaluate and estimate your actual requirement for life insurance. You’ll need to ask and address two inquiries to do that:

What Kind of Life Insurance Do You Need?

There is more than one method to give a satisfactory response to this question that won’t leave you without enough money to pay for life insurance.

What you hope to accomplish with your coverage should be your first priority. You need a lot less insurance to replace all the income your family stands to lose if you pass away prematurely than you would if you were simply concerned with paying the expenditures you know or think you’ll leave behind when you die, plus a buffer to allow for inflation and unforeseen expenses.

Also, keep in mind that the policyholder’s real and proportionate income (related to that of their spouse or partner’s) will always raise the demand for life insurance. And that holds true even if the policyholder has no intention of paying out of pocket for any costs in the foreseeable future.

It’s far easier for a surviving spouse to keep up with the mortgage, vehicle payment, and school expenses when they’re responsible for 70% of the family income rather than only 30%.

In addition, they are in a far better position than a nonworking surviving spouse, who will have a much lower earning potential in the near future (particularly if they are responsible for small children). For major or single breadwinners, income replacement coverage is a must.

To sum up, here’s a very broad response to the topic of how much life insurance is enough: your yearly income multiplied by 10.

To be more precise, it’s a jumping off point from which you may determine the appropriate level of protection for your needs. This is not a certain fact at all.

At age 30, with a yearly salary of $50,000 and a $2,000 monthly mortgage payment shared with a partner who also earns $50,000 per year, life insurance coverage of $500,000 is more than enough.

If you could see yourself in 20 years, you’d realize that $500,000 isn’t nearly enough when you’re gray and decorating your third Ivy League dorm room in as many years.

How long will you require coverage?

You can skip this step if you’ve already settled on a permanent life insurance policy. We both know the correct response is “indefinitely.”

If you’ve decided against purchasing a permanent policy and will instead get term life insurance, you’ll need to determine how long you’d like your policy to be in force.

For a death benefit to be adequate as part of a retirement income replacement strategy, you need insurance that covers the time span between the time of your death and when you want to retire.

All that matters is that the death benefit, whenever it is paid, is sufficient to replace the money you never earn, not that the policy lasts until your last year of work.

A $700,000 death benefit paid out five years prior to the predicted last day of work would be more than enough to see your surviving family through if you plan to earn an average of $100,000 per year throughout the remaining five years of your career.

There is a reverse age-related trend, where life insurance rates rise while the need for coverage declines. Therefore, rather than buying a single, more expensive, long-term life insurance policy with the same death benefit, many would-be policyholders instead opt to “ladder” numerous, shorter-term policies together.

In order to reduce monthly and lifetime premium costs and excess coverage, a life insurance ladder provides substantial coverage in the beginning, then levels down as the policyholder’s prospective income and expenses drop.

Bottom Line

People tend to overstate the difficulty of looking for life insurance. To be sure, it’s unlikely that anyone who claims they enjoyed the procedure is being truthful. Getting life insurance is similar to other tedious but necessary tasks, such as signing up for a cash-back credit card.

Nothing can make the hunt for a life insurance policy something that prospective policyholders can’t wait to do. However, anxiety and confusion may be mitigated by being informed about what to anticipate and how to select the appropriate coverage.

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