Let’s talk insurance again – this time, life insurance. How does it work, and who should have it?
Life insurance is, of course, something you get because you are betting that you will die soon (or your wife wants to make that bet…).
It is still based on life and death. Like all insurance the idea is to pay a little money now for stability and predictability in the case of something going wrong later. In this case your death. The stability you are purchasing is stability for your wife and children or other dependents. Whoever you designate as the beneficiary gets money if you die while you have coverage.
This should tell you two things. One, that the amount of your coverage should be enough to do for your family what you planned to do for them with your work. That should be enough to pay off the mortgage and keep your family in their home, get the kids through school if you were going to help pay for that, or whatever else is going to be an expense for your family. Or if you are the stay-at-home dad, to pay for hiring out those services. Add in the cost of a funeral, and that’s how much you need. For most families, it’s likely to be $1-2 million dollars if there are young kids that you want to be sure will be seen through to adulthood.
You may or may not be getting life insurance through work. If it’s cheap, feel free to take it, but don’t rely only on it. If your life insurance is all through work and you die between jobs your family gets nothing. The coverage you get through work is unlikely to be enough to fully cover you. Instead, you should get private life insurance to the full amount your dependents would need. We’ll come back to the price in a minute.
The second thing is that you only need life insurance if you have someone depending on you to keep making money or to do work that would otherwise need to be hired out. If you are single and have no children or dependents, you don’t need life insurance. And if you are married, your kids are already out on their own, and there is enough of a retirement set aside for your wife to live on, you don’t need life insurance anymore either.
For this reason the basic kind of life insurance is Term Life insurance. That means it only covers you for a certain number of years. Usually that’s 10-30 years in increments of five. You will pay a monthly premium during that time, and if you die during that time, your beneficiaries will get the payout. The exact price will depend on your health and risk factors, but this type of life insurance is by far the cheapest kind, and it’s a good deal. It’s a peace of mind well worth the cost.
It’s so cheap because you are unlikely to die in the time period if you are buying this at the right time. If you buy a 30-year policy when you get married in your twenties or a 20-year policy when you start having kids in your thirties, then you will still be young when your policy runs out. Most people don’t die in their thirties or forties even with unhealthy habits, so it’s a good risk for the insurance company.
So if you just wanted a quick summary on life insurance and a recommendation, there it is. If you have family or dependents, add up how much money they would need if you died tomorrow. Then go out and get a term life insurance policy, outside of work, for that amount. Make the term just long enough that your kids will grown and your retirement accounts full enough when the coverage ends.
If you’re interested in why there are so many other kinds of life insurance, and why they are all a bad deal, you may accompany me a bit further.
The basic deal for term life insurance is pretty solid for everyone. The insuree gets peace of mind at a low price, and the company makes a neat profit because they usually don’t have to pay out. But the company always wants more money. At some point, insurers started coming up with more complicated versions of life insurance. To make this something they could sell they had to mix life insurance with other types of financial products, since people in middle age and beyond don’t generally need life insurance unless their financial lives have gone awry. The problem is these ‘hybrid’ products cost much more and are generally not a good deal compared with covering your bases separately.
I’ll use Whole Life as an example. Whole Life is life insurance that never ends until you die. It’s sold as a guaranteed payout. Which is also why it’s much, much more expensive than term life. In a term life deal, the company almost never has to pay. But in whole life, the company ALWAYS has to pay. That’s a very different cost scenario. And this expense is why almost half of people who buy a whole life policy stop paying the premiums and lose their coverage.
A similar pitch is Universal Life insurance. Universal Life insurance is a permanent life insurance marketed as a retirement investment or tax-advantaged vehicle. Basically you pay more than it costs to insure you, and the extra goes into a cash value that can accumulate based on the stock market or a minimum guaranteed return. That extra can be withdrawn later as a form of retirement fund. The problem with this is that you would have come out ahead with just buying a cheaper term life policy and investing the difference in premiums into a low-cost index fund along the way. Think about it like this. The insurer has to cover the costs of insuring you and make a profit. The return with them won’t be as high.
As a private buyer you may see life insurance with worlds like whole, variable, universal, survivorship, etc. You may also see ‘hybrid’ policies mixed with other kinds of insurance like long-term care. But all of these are likely to be a much worse deal than the term life and investing for retirement, or getting the other kinds of insurance, separately. They only exist to make more profit, not to help you. Don’t be fooled. Stick to the basics here.