Life Insurance – What Kind Do You Buy?

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Once you determine how much life insurance you need, you should buy term life insurance. There are other types of life insurance (like whole life, variable universal, etc) that insurance agents might try to sell you, but resist the sales pitch and buy term life insurance.

Why term life? It’s the cheapest, and it provides the protection you need. Besides it’s simple to understand. You pay premiums on a regular interval and if you, the insured, cash in the proverbial chips, your designated beneficiary receives a pre-set lump sum payment. I feel comfortable with that because I understand it.

See, the alternative to term insurance is “cash value” insurance. You might have heard of whole or universal life insurance; they all fall under the umbrella of “cash value” insurance. The way the insurance companies explain it, in a cash value policy, a part of your premium goes to some account where it can grow in value, be it in the stock market or a savings account. You see the attraction, right? Where your premiums are basically “gone” in a term life policy, a cash value policy has the appeal of deploying a part the premium as a savings/investment vehicle. So you’re now saying what’s the catch? Cash value policies are expensive; for the same amount of coverage, cash value policies are about eight times as expensive.

Cash value policies are expensive; for the same amount of coverage, cash value policies are about eight times as expensive.

Cash value life insurances are aggressively sold by insurance agents because the commission for selling them is so high. Great products sell themselves without advertisements or commissions. The fact that insurance companies are willing to pay agents high commission should be a tipoff that something is potentially fishy. With cash value policies, in essence, you end up paying higher premiums to pay for these expensive commissions. Also, cash value life insurance, during the first few years of the policy, does not allow you to redeem any of your saved money because the insurance company has paid most of that money out as commissions. With very few exceptions that has to do with estate taxes for the wealthy, cash value policies rarely make sense.

So what to look for in a term life insurance? There are two features you should keep in mind when choosing term life insurance.

  1. The interval between premium increases – You have to choose how often your premium adjusts. What? You choose how often your term life premiums will increase (they won’t decrease because your premiums will get higher as you get older) – every 5, 10, 15, or 20 years. No brainer, right? You’re saying that the interval should be as long as possible. 20 years. Why not lock in a rate for a long time in case your health changes? The longer interval gives you the peace of mind of having the same premium for a long time regardless of your health. The downside is that the longer the interval between premium adjustments, the higher your initial premium and subsequent premium increase will be. So you’re paying more in the early years of coverage. This is disadvantageous if you want to switch life insurance somewhere in the middle when you have already paid for the expensive early portion. With a shorter interval – say 5 years – you will possibly have to undergo physical exams to qualify for the lowest rates frequently. Your health can also change for the worse during that interval and if it does, your premium will go up. So as you can see, there are two opposing forces here. Something in the middle – 10 years – is probably a good compromise.
  2. Guranteed renewability – Second, you should buy a policy with guaranteed renewability. Just like I recommended non-cancellable and guranteed renewable disability insurance policy in a previous post, you should buy an insurance with guaranteed renewability because you don’t want to have the policy be cancelled due to poor health.  This might cost you a bit more, but it’s worth it.

As for where you can buy life insurance, I would recommend doing a google search and shopping around for the best rates. I just googled “term life insurance quote” and got multiple search results: Geico.com, Metlife.com, term4sale.com, intelliquote.com, selectquote.com, etc.  Just make sure you pay attention to the two features I just talked about.

One more word about life insurance. Your life insurance needs will most likely change over the years. Remember, life insurance protects against the loss your income over a period of time and the financial liabilities that will remain if you pass on. By the time you retire, your life insurance needs should decrease.  Why?  Hopefully the reason will be that you have a high net worth.  Remember, net worth is assets minus liabilities (debts).  By the time you retire, you should have accumulated enough assets and paid off most, if not all, of your debts including mortgage and your kid’s college tuition.  And if your assets are pretty liquid, they can substitute for insurance coverage.

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