How to Choose Life Insurance

Guide Note

No one wants to think about life insurance, but without it, your family could face financial hardship after you are gone. With all the different types of life insurance policies out there, selecting one can be confusing. Understanding the basics, such as those listed here, will help you when you try to choose the right life insurance policy for you and your family.

Table of Contents

Life Insurance Tips
  1. Not everyone needs life insurance.
  2. Your policy should equal at least 5 times your annual earnings.
  3. Term life insurance is cheaper than permanent.
  4. Shop around before purchasing any life insurance.
  5. Some polices can be good investments.
  6. Talk to a good financial adviser before buying life insurance.

Disclaimer

The content in this page is not a substitute for professional financial advice. Please contact your financial adviser before using the information presented here.

Introduction

  • Many people think that only the elderly need life insurance policies, but life insurance is equally, if not more, important for the young and middle-aged. Read of for details on how to choose the best life insurance policy for you.

Step 1: Decide if You Need Life Insurance

  • Despite what insurance salespeople might tell you, not everyone needs life insurance. Whether or not you need life insurance is dependent on several factors. If you are single with no outstanding debt and a good savings account, you probably don't need life insurance.
  • Several reasons you should consider purchasing life insurance include:
  1. You have dependents.
  2. You want to cover any debts or death expenses (burial, funeral, etc.) following your demise.
  3. You own a business.
  4. To cover federal "death" taxes and state "estate" taxes.1
  • In some cases, financial advisers will tell you to use life insurance as a form of investing your money. However, other advisers will tell you to not get life insurance and invest your money elsewhere. Make sure you seek out sound advice before making a decision.


Step 2: Decide How Much Life Insurance You Need

(Creative Commons photo by Leonid Mamchenkov)
(Creative Commons photo by Leonid Mamchenkov)
  • Once you have decided that you need life insurance, you will need to calculate how much life insurance that you need. The sad fact is that most people do not have enough life insurance.2
  • Some people will tell you that you need approximately five times your average annual income. However, there are few other factors you may want to figure into your calculations such as:
  1. Any additional income that you bring in (bonuses, 401(k) contributions, etc.)
  2. Any expenses that could occur with your death: funeral expenses, burial costs, etc.
  3. Any additional expense that might occur because of your death such as a tax preparation, education costs (if your spouse would need to go back to school to get a job), cost of health insurance and moving expenses
  4. Any money you would receive from Social Security and any life insurance policies you have from your employer

Step 3: Understand Life Insurance Basics

(Creative Commons photo by Mike Baird)
(Creative Commons photo by Mike Baird)
  • There are two major types of life insurance: whole life and term life.
  1. Permanent life insurance is insurance that does not expire and has a monetary value.
  2. Term life insurance is life insurance that is good for a set period. After that term, it is no longer of any value.
  • Another way of thinking about it is the difference between buying versus renting a house. Term insurance is like renting a house. During the "term" of your lease, you get full use of the house and property. When you stop paying rent, you lose the house and you have not built up any equity.
  • Permanent life insurance is like buying a house. You don't lose your payments and can actually cash in (or sell) your policy early or borrow against it.5 Of course, that is a very simplistic way of looking at it.

Costs

  • Life insurance policies greatly in price for two reasons.
  1. The first is the type of policy it is. Term life insurance policies are cheaper than permanent life insurance policies.
  2. The second variable involves the person who is being insured. Certain factors can raise your insurance rates.
    • The older you are the more you will pay.
    • Smokers will pay more than nonsmokers.
    • Overweight people will pay more than people who are average weight.
    • People involved in "high-risk activities" such as flying, sky diving, rock climbing or scuba diving will also pay more. 6

Step 4: Understand Permanent Life Insurance

  • Permanent life insurance has higher premiums than term life insurance, but it does not expire.7 Permanent life insurance is good for people who:
  1. Want lifelong protection
  2. Want to accumulate cash on a tax-deferred basis 8
  3. Want their premiums to remain constant
  4. Want to be able to withdraw or borrow against their policy

Types of Permanent Life Insurance

  • Essentially, there are three major types of permanent life insurance: whole, universal and variable. However, these these three can overlap. As stated earlier, these types of life insurance policies will not lapse as long as you continue paying the premiums.
  • Whole Life Insurance policies have a fixed annual premium and death benefit. Whole life insurance also includes a savings element with it that can will build up the cash value of the policy.
  • Universal Life Insurance has a flexible annual premium and flexible death benefits. It gives the insurer the option of paying over the premium. That money is then credited to the cash value of the policy and earns interest.
  • Variable Life Insurance is an option that can be attached to either whole or universal life insurance that allows the insured to choose what type of investment the cash-value will be placed into. It works similar to a 401(k) plan.9 Variable life insurance offers consumers a [greater opportunity of return] than other types of life insurance.10


Step 5: Understand Term Life Insurance

(Creative Commons photo by Sarvodaya Shramadana)
(Creative Commons photo by Sarvodaya Shramadana)
  • Term life insurance is good for people who:
  1. Need life insurance for only a short period of time
  2. Have a fixed income5

Types of Term Life Insurance

  • Level term life insurance has a set premium, term and payout. For example, someone might pay $100 a year for 20 years for a policy worth $200,000. The terms are usually 10, 15, 20 and 30 years.12
  • Renewable term life insurance is one that is good for a year, but automatically renews at the end of that year. Each time it is renewed, the premium changes based upon how probable the insured might die. Typically, this means that the premium will go up.13
  • Decreasing term life insurance has a level premium, but a decreasing level of coverage. In other words, it pays out more the first year than it does the second year. This type of term life insurance is rarely used.13

Options

  • There are several optional clauses that can come with term life insurance.
  1. A return-of-premium term policy is one that will refund you your premium payments after the end of the term is over, providing you keep the policy for the entire term.
  2. Accelerated death benefits allow you to collect a portion of your death benefit should you become terminally ill.
  3. A disability waiver of premium will waive any premiums made if you become permanently disabled.
  4. A conversion option allows you to change your term policy into a permanent one at any time before it expires without submitting evidence of insurability.

Step 6: Purchase Your Life Insurance

  • Once you have decided how much and what type of life insurance you are planning on purchasing, it is time to find a good insurance agent. The best thing you can do is to shop around for the best deal.
  1. Get at least five proposals in writing and compare them.
  2. Do not make any quick decisions.
  • Remember, you are going to have this policy for a long time. Make sure it is exactly what you want before paying any money.

Conclusion

  • Most people don't like to think about their own death, but you cannot afford not to think about life insurance. When a death occurs, the last thing family and loved ones should have to deal with are additional financial problems.


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References for How To Choose Life Insurance

  1. ↑ Insurance Information Institute: Why should I buy life insurance?
  2. ↑ Life Insurance Advice: How Much Life Insurance Do You Need?
  3. ↑ Life and Health Insurance Foundation for Education: Human Life Value Calculator
  4. ↑ Inheritance Network: How Much Do I Need?
  5. ↑ 5.0 5.1 Life and Health Insurance Foundation for Education: Term Insurance
  6. ↑ About.com: Understanding and Choosing Life Insurance
  7. ↑ Inheritance Network: Insurance Comparison
  8. ↑ Life and Health Insurance Foundation for Education: Permanent Insurance
  9. ↑ Inheritance Network: Permanent Insurance
  10. ↑ Wikipedia: Permanent Life Insurance
  11. ↑ CompuQuotes: When To Choose Whole Life Insurance Over Term Life
  12. ↑ Wikipedia: Term Life Insurance
  13. ↑ 13.0 13.1 Inheritance Network: Term Insurance

Resources for How to Choose Life Insurance

How To Choose Life Insurance Videos

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