The Complete Guide to Life Insurance

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Single or married, young or old, many of us should have some sort of life insurance. But wading through the sea of information on life insurance can be confusing and complicated.

This guide will help you decide whether to get life insurance, figure out which type will best meet your needs, and shop around for the best life insurance coverage for your money.

Do You Need Life Insurance?

If you died today, would someone suffer financially because of it?

For many of us, the answer is yes. At the very least, someone would have to pay for your funeral or memorial.

The National Funeral Directors Association says that nationally, the average cost for a funeral service in 2012 was about $7,000, more than $8,000 if mourners need to buy a vault, which most cemetery’s require.

Even if you leave no other end-of-life costs behind, someone has to pay for at least basic funeral/interment costs. And none of us wants to leave those costs to mourning spouses, family members or friends.

Beyond that, you may leave things such as debt, taxes or ongoing care of a spouse or children. If you’re married, have kids, are a small-business owner, support your parents, siblings or other individuals, you probably need at least some life insurance coverage.

We’ll talk more about how much coverage you need in a minute, but for now, it’s enough to know that you need life insurance if anyone might suffer financially when you die.

Some People Don’t Need Life Insurance

With that said, there are people who don’t need life insurance. If no one will suffer financially when you die, then life insurance isn’t a necessity for you.

For instance, if you’re single and have no children, few debts and enough in savings to cover end-of-life costs, then you shouldn’t need life insurance. Likewise, older adults with self-supporting grown children and enough money to cover end-of-life expenses won’t need life insurance.

If you’re young, single and healthy, you may want to look into buying a term life insurance policy now, when your premiums will be much lower throughout the term.

On the flip side, some retirees can benefit from a life insurance policy as part of their estate planning. If you have an estate worth millions, a life insurance policy could help protect your wealth from estate taxes, so that you can pass more on to your heirs.

In general, if no one is relying on your for financial support and if your assets are enough to cover your funeral costs so that your family isn’t stuck with them, you probably don’t need life insurance.

Types of Life Insurance

One of the most confusing aspects of life insurance is that there are so many types. The two main categories, term and permanent life insurance, are divided into many subcategories. And some of the terminology surrounding life insurance is confusing as well.

First, let’s look at a basic breakdown of the two main life insurance categories, and then we’ll check out the pros and cons of each option.

Term Life Insurance

Term life insurance provides a set amount of coverage for a fixed term and usually comes with fixed monthly or annual payments.

For example, Joe could buy a $100,000, 20-year term life insurance policy for $30 a month (a completely fictional premium payment, by the way). So for 20 years, Joe would have $100,000 of life insurance coverage if he happened to die, so long as he kept up with his $30/month premium payments.

Term life insurance, unlike whole life insurance, is just a death benefit. So if you die during the stated term, the beneficiaries get the money. If you don’t die during the term, no one gets the money.

Because it’s just a death benefit, term life insurance premiums are typically low. The less likely you are to die during the term, the lower the premiums will be. So if you’re young and in good health, you could pay a relatively modest premium for a large amount of life insurance coverage.

One thing to keep in mind, though, is that you have to prove your insurability with term life insurance each time you renew a term.

If you’re young, healthy and have no acute or chronic illnesses, you’ll qualify for a great insurance rate. If you’re older or have some health issues, including obesity, a history of smoking, diabetes or other conditions, you’ll probably be able to get term insurance coverage, but you’ll pay more for it. Those with serious health problems may be uninsurable and unable to get term life insurance.

Types of Term Life Insurance

Though term life insurance is simpler than whole life insurance, it still comes with many variations. The main types of term life insurance include:

Level Term Life Insurance: With this type of life insurance, the premium is guaranteed to remain level for the entire insurance term. So if you start off paying $20 a month, you’ll continue paying $20 a month until the end of the life insurance term.

Most level term life insurance policies have a renewable option that will let you renew your policy for a maximum guaranteed rate if you need more coverage at the end of your term. As long as you meet insurability requirements, you could extend your policy without paying through the nose, hopefully.

Return of Premium Term Insurance: As you might guess, this type of insurance gives you the option to get your premiums back, minus fees and expenses, if you outlive your life insurance policy. These policies tend to come with much higher premiums, but can be a way to regain some money if you don’t end up using your life insurance plan (i.e., you don’t die during the term).

Annual Renewable Term: This is a single-year term life insurance policy, which you have to renew at the end of each year. Since your likelihood of dying in the next year are slim, you might save some money on premiums with an annual renewable term.

However, you are taking a risk by assuming that you’ll be insurable at the end of the one-year term. If you contract an illness or otherwise become uninsurable, you could be up the proverbial creek.

Decreasing Term Insurance: If you’re buying a life insurance policy to cover something specific, like dependent care costs or your mortgage, a decreasing term policy is something to look into. With this type of policy, your premium remains the same throughout the term, but the face value of the policy decreases year by year.

Decreasing term premiums tend to be lower than level term premiums because the older you get, the less the insurance company would need to pay out upon your death.

Convertible Term Insurance: Many term insurance policies (including the types listed above) come with the option to convert the policy to a whole life insurance policy within a specific number of years, sometimes without proving that you’re still insurable.

If, for instance, you have a 10-year renewable term insurance policy but end up with a medical issue that keeps you from renewing it, you could convert the policy to some type of whole life insurance policy within a certain time frame. This keeps you insured and doesn’t require you to prove a clean bill of health to keep that life insurance.

Comparing Term Life Insurance

The following chart from State Farm compares three types of term life insurance. Premium amounts are based on a healthy 25-year-old female in Illinois, so your premiums would vary. However, this chart breaks down the differences in types of term life insurance and also shows the difference in premium amounts.

Term Life Insurance Comparison

Permanent Life Insurance

Unlike term life insurance, permanent life insurance isn’t just a death benefit. It’s also a sort of savings or investing vehicle. Because of this, permanent life insurance is both more expensive and more complicated.

Permanent insurance comes with higher payouts for insurance companies and brokers, so consumers are sometimes pressured to buy this type of insurance. However, most third-party financial advisers often prefer term life insurance over permanent.

This is because permanent life insurance has much more expensive premiums, part of which goes into an investment account. Much of the time, you’re better off investing that extra money on your own and will get better returns with lower fees.

Also, the higher cost of permanent life insurance means that people are more likely to stop making payments during tough financial times. The policy then lapses, and renewing or buying a new policy later will likely result in even higher premium costs.

Still, there are times when permanent life insurance is a good bet. For example, most parents need life insurance only until their children are old enough to support themselves, making term insurance a good bet. But if your children will never be fully self-supporting, a permanent life insurance policy can give you peace of mind, knowing that you’ll be able to provide for your child indefinitely.

Also, if you have a large estate, a permanent life insurance policy can protect it from heavy taxes. Typically, the death benefit of a permanent life policy is distributed free of taxes, so some estate planners will use this death benefit to pay the taxes on the rest of the estate.

Types of Permanent Life Insurance

As with term insurance, permanent life insurance comes in several flavors. Because this is a complex product, be sure you understand what you’re getting into before choosing your insurance policy.

Whole Life: This is the most basic type of permanent life insurance and comes with a death benefit and a savings component, which is called the cash value.

With a whole life policy, part of your premium payment goes to ensure that you have a death benefit, as with term insurance. The rest goes into a savings account on which the insurance company pays dividends, typically a guaranteed amount per year. The investment and dividends add up to make your policy’s cash value.

With most whole life policies, you can withdraw a limited amount of money from the policy’s cash value. You could also choose to surrender the policy, getting the cash value, minus (often hefty) surrender fees, rather than leaving your death benefit to the beneficiaries of your policy.

The following images give you an example of what the paperwork for a whole life insurance policy might look like. Note that the premiums are high compared with term life insurance premiums, even though this policy has a relatively low $100,000 death benefit.

The second image shows you what the cash value of the policy would be, depending on how long you’ve paid into it. Again, these are only samples and don’t have much bearing on what you’d pay for a similar whole life policy.
Whole Life1

Whole Life2

Universal Life Insurance: Universal insurance is a little more complicated than whole life, and it also has a more aggressive investment component. Often, the cash value for this type of insurance policy is tied to an interest rate that adjusts each year.

Universal life insurance is a little bit riskier than whole life, because it doesn’t guarantee a certain cash value. Because of the risk, universal life insurance is typically cheaper than whole life insurance.

One potential benefit of universal life is that the premium is somewhat flexible. Pay more, and more goes into the investment account. Pay less, and less goes into the investment account. Also, you can use the money in your savings account to pay your premiums, if necessary.

Variable Life Insurance: Variable life insurance policies are similar to universal policies, but they offer more choices in investments. The value of your policy can rise or fall with the value of the underlying investments, which can include equities.

Variable life insurance policies can be a little scary in a down-turning market, because you could end up losing serious cash. And many individuals eventually let their premium payments come out of a variable life insurance plan’s cash value.

If your cash value gets too low, your policy could lapse, leaving you without any coverage.

Comparing Whole Life Insurance

While the three options above aren’t the only options insurance companies offer, they’re the main options within the permanent life insurance category. However, different life insurance companies will offer plans with more specific differences and details.

Here’s a comparison of two permanent life insurance policy options from State Farm. Again, these policies are based on a healthy, 25-year-old female from Illinois.

Permanent Life Comparison

Term vs. Permanent: Which is Best?

Deciding between term and permanent life insurance is, for some people, simple. For your average consumer, term life insurance is the best bet.

The more-affordable premiums of term life insurance free up money for other important financial matters, like saving for emergencies, or paying for a child’s education. And most of the time, if you invest extra money on your own, you’ll get better returns than if you let an insurance company invest it on your behalf (and swipe quite a bit off the top in fees and commissions).

Still, there are times when permanent life insurance makes sense. If you know you’ll need to financially provide for a child or spouse for a lifetime, the permanent life insurance can give you more peace of mind. Or if your estate planner recommends permanent life insurance as a way to rescue your large estate from taxes, it can be a good option.

This quick video can help you compare term and permanent life insurance, and it gives good advice on which you need and when.

The bottom line is that for most of us, life insurance should be just that - insurance. Just like car insurance or home insurance, you hope you’ll never have to use your life insurance. But having it is important, just in case.

How Much Coverage Do You Need?

One of the biggest pieces of shopping for life insurance is deciding how much coverage you need. You can get as little as a few thousand dollars or as much as millions.

There’s a lot to consider when deciding how much life insurance you need. And how much insurance you need will depend on your life situation. Plus, your life insurance needs will vary throughout your life.

The main goal for life insurance is to cover the cost of dying and replace your income if you have dependents. This video from Investopedia gives you a basic breakdown of how you might calculate replacement income:

If you watched that overview, you can see that you’ll probably need to have life insurance worth several times your annual income, especially if you’re the family’s primary earner.

The rule of thumb for life insurance varies dramatically, depending on whom you’re talking to. Some financial planners advise getting 5 to 7 times your income in life insurance coverage, while others advocate having 10 times your income or more. We have written in more detail about the various rules of thumb concerning how much life insurance to buy.

It depends on your life situation, your life insurance term, how much money you make, and a host of other factors. First, let’s look at some of the goals you might have with life insurance, to give you an idea of how to go about calculating your life insurance needs.

Then, we’ll look at specific (though fictional) situations from different consumers shopping for life insurance, to show you how these factors work together in different situations.

Life Insurance Goals

Depending on where you are in your life and who you’re responsible for, you could have any number of goals for your life insurance policy.

If you’re in your early 20s and don’t have a spouse or kids yet, you may just want a little life insurance coverage to ensure that your family doesn’t have to foot the bill for your potential funeral. But as you age and become responsible for other people, your life insurance goals are likely to become more complex.

Here are some of the most common goals for life insurance, which would all have a bearing on how large a policy you might want:

  • Covering end-of-life and funeral expenses
  • Paying off debts, including a mortgage
  • Allowing your family to maintain its lifestyle after you’re gone
  • Funding your child(ren)’s college fund
  • Allowing your business to continue operating without you
  • Paying off the taxes and transfer expenses on your estate

Obviously, the more you want to do with your life insurance, the more insurance you’ll need. For instance, if you just need to cover a few debts and your end-of-life expenses, you could get away with a small policy. But if you want to replace your income for 10+ years and fund your child’s college account, you’ll need more insurance.

When you have young children, you may need enough insurance to replace your income for 20 years and to fund college accounts. But as your children age, you’ll need less and less insurance coverage because they’ll be ever closer to independence.

Let’s run life insurance calculations for a few different situations, so you can get a feel for what your life insurance needs might include. For these calculations, I’m using the Life Foundation Insurance Calculator.

Estimate #1: Jeff, a working dad with two kids and a wife

Jeff would like to replace his income for his family until his kids are grown, and he’d also like to fund college for his children. Here’s what his calculation looks like:

Term Calculation 1

Term Calculation 2

Example #2: Mary, a single mom with two older kids 

Mary recently started shopping for term life insurance when she switched jobs and no longer had term insurance provided at work. Long ago, Mary designated a close family friend to be her children’s guardian should something happen to her, but she wants to be sure her life insurance covers her children’s needs and their future college education in the event of her death.

Here’s what her calculation looks like:

Term Calculation 4

Term Calculation 3

Example #3: Jackie, a married woman with no children

Jackie and her husband, Ben, recently decided to get life insurance, even though they don’t have children. Their life insurance goal is to pay off their debts and to replace income for a couple of years to give the surviving spouse time to grieve.

We didn’t count Ben’s income in this life insurance calculation because the point is to replace Jackie’s income for a limited period to give Ben some breathing room in case she died.

Term Calculation 5

Example #5: Alicia, a stay-at-home mom to three kids 

Alicia’s husband makes an excellent income and has a large life insurance policy of his own. But the couple recently decided to get life insurance on Alicia because she does so much for her family. As a stay-at-home mom, she provides cleaning, child care, meal preparation, and a host of other essentials that her husband would have to pay for if she died.

The goal isn’t to replace Alicia’s nonexistent income. Instead, she and her husband want to be sure that he’d have enough money to pay for the services Alicia provides for the family while using his income to maintain their lifestyle.

This infographic from Salary.com’s Mom Salary Survey 2013 shows how much Alicia’s services would be worth to her family based on a national average. We’ve used 45 percent of this average figure in Alicia’s life insurance calculation. If she wanted a closer estimation of how much it would cost her family to replace her, she could price out various services in her actual hometown.

stay at home mom infographic

The assumption here is that Alicia’s husband would outsource only certain things that she does for her family.  Here’s the life insurance estimate they came up with:

Term Calculation 6

Note: Something is Better than Nothing

The goal with the above examples is to show you what life insurance estimates look like based on various scenarios. It’s surprising how much money you’d need to replace your income for even a decade.

The point here is that something is better than nothing. If you can’t afford the premiums on a hefty life insurance policy, opt for a smaller policy rather than none at all. You’ll be able to cover some of your family’s expenses if something should happen to you, and you won’t have to worry about your policy lapsing because you can’t cover the high payments.

Process of Getting Life Insurance

Shopping for and getting life insurance isn’t difficult. You can shop around online to get an idea of premium options, or you can call insurance agents or brokers to do some of the shopping for you.

The Internet is flush with insurance shopping options, which can help you compare apples to apples and get life insurance quotes. However, if you give these sites your telephone number and/or email address, expect to be contacted by salespeople for life insurance companies for months. We do maintain a list of life insurance options that is updated daily.

When you get a life insurance quote, remember that it will be based on your estimated health class. The higher your health class, the lower your premiums because a higher health class means you’re less likely to die during your insurance term.

If you’re generally very healthy, not a smoker, have no previous or underlying conditions, and maintain a health body mass index, you may qualify for the highest health class. But if you have any health problems, have a family history of cancer, have high blood pressure or high cholesterol, or have a high BMI, you’ll be bumped to a lower health class.

It’s possible to estimate your health class when you sign up for insurance quotes, but you should know that most life insurance companies will verify this. When my husband and I bought our life insurance policies five years ago, we had to meet with a home health nurse to be weighed and to have our blood pressure taken. The older you are and/or the larger the insurance policy for which you’re applying, the more tests you may need to undergo to verify your health class.

One thing to note as you shop around for insurance: different companies have different health class criteria. One company might knock you into a lower health class for slightly high cholesterol, even if you’re otherwise healthy, while a second company might have tighter blood pressure or family history restrictions.

It’s all how individual companies assess risk. If you know that you have one or two health issues that might bump you to a lower health class, consider working with an independent insurance agent.

Good agents will know which companies have the strictest rules for which issues. This means that an agent may be able to direct you to the company that will give you the best premium in the long run, which could save you quite a bit of money.

5 Tips to Save on Life Insurance Premiums

As you’re shopping around for life insurance, there are things you can do to reduce your life insurance premiums. Here are five:

1. Apply earlier. Age is one of the largest determining factors for life insurance premiums. The younger you are when you apply, the less you’ll pay for life insurance. So if you’re on the fence about applying now or later, go ahead and apply now. You can always add a second policy later or increase your coverage if you need more coverage as you age.

2. Opt for a shorter term. The longer you life insurance term, the more expensive your policy will be. Remember, level term life insurance looks at how old you are now and how old you’ll be when the policy expires, so a longer policy means higher premium payments. So if you know your kids will be out of the house in 10 years, don’t get a 20-year policy.

3. Get less insurance. Depending on your situation, you may not need to replace all your income – or even half – for a decade or more. You could provide for your family’s needs with less life insurance. If you’re unable to pay a high life insurance premium, opt for a lower face value. Your family will still have some protection, but you won’t have to pay so much each month or year.

4. Improve your health rating. The cost difference between health classes can be as much as 50 percent. That’s a lot of money. If you don’t need insurance coverage right now, work on getting healthier before you apply. Lowering your cholesterol and blood pressure, and losing weight if your BMI is too high can help reduce your premiums by quite a bit.

5. Shop around. As with other insurance products, life insurance premiums can vary dramatically from one insurer to the next. So be sure you shop around for rates online, or talk with an independent insurance agent to find the best price for you.

Published or Updated: October 29, 2013
About Abby Hayes

Abby is a freelance copywriter and blogger who writes on everything from personal finance to health and wellness. She spends her spare time bargain hunting and meal planning for her family of three.

Comments

  1. Money Beagle says:

    This is a very informative post that I’ve bookmarked and will be reading in greater depth here in a few weeks. We’re getting insourced and our ‘new’ employer has less life insurance coverage than my current employer, so I will likely have to start shopping around, as the max amounts are no longer sufficient for our needs. This info will definitely help, and maybe I can even use some of the information here in negotiations as I will have to point out that this will be a cost to me.

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