I get questions about life insurance all the time: Do I need insurance? What kind should I get? How much coverage do I need?
One of the reasons I get so many questions about life insurance, and that I’m so passionate about it, is because I sold life insurance for a very long time. However, I stopped selling life insurance when I started Gen Next, so I’m equipped to offer you some objective advice.
Why you need life insurance
Personally, I benefited from life insurance when my mother passed away. I was just 20 years old, and that money made a difference during a difficult time; we were able to take care of her funeral and burial.
And that’s really the goal of life insurance: to provide some financial security to your loved ones. If you want the more technical definition, life insurance is a contract between the insurer (the company) and a policy holder that guarantees a payment to the plan beneficiaries when the insured dies. This is called a death benefit. In exchange, you pay premiums, similar to car insurance.
In my opinion, if you have a pulse, you need life insurance. So let’s look at the types of policies available and how they work.
Term life vs. permanent life insurance
This is the biggest distinction among life insurance policies.
Term life insurance covers you for a set period of time, or a term. If you have employer-sponsored life insurance, it’s likely term life insurance, covering your period of employment. But many people choose to buy term life insurance that lasts for 10-, 20- or 30-years.
Permanent life insurance, as the name implies, covers you permanently — it never expires. It’s often referred to as whole life insurance, since it covers you for your whole life. These plans tend to offer more flexibility than a term life plan. Most notably, you may be able to borrow against the cash value of your policy and use the money while you’re still alive.
However, most people aren’t in a situation where they’re going to need life insurance as a savings vehicle. And once you dip into your cash values, it changes all of the numbers you were quoted in your policy.
Permanent life insurance also comes with a cost. Premiums tend to be much higher: between five and 15 times more expensive than a term-life policy. To offset the cost, people tend to buy less coverage, which in my opinion, is a mistake.
Other types of policies
Most term life insurance plans have the option to convert the policy (or part of it) to a whole life plan. One upside of converting a term policy (versus purchasing a new plan) is that you generally don’t have to go for a new physical or answer new questions about your health.
For example, I have a term-life policy. It’s a 20-year plan, and it has the option to convert down the line. I like to look for convertibility in plans. Most people can get away with term policies for a long time. As you get older, a permanent policy may make more sense. If you already have term life insurance, check to see if the policy is convertible, and if there’s a deadline for converting the policy is.
Variable life insurance plans are permanent life insurance plans with a cash value, but the money in the plan is invested — so the ultimate payout depends on the performance of those investments. The investment options are limited to “sub-accounts,” which are similar to mutual funds, but exclusive to the insurance policy. It’s important to research the investment options in detail before purchasing a variable life policy.
The invested money grows tax-free, like a retirement account. It’s possible to take loans out of these policies later in life without paying taxes on the money, though this process can be complicated and is best done with the help of an advisor.
Choosing the right life insurance
Which type of policy is right for you depends on your goals and other aspects of your financial picture.
- How healthy are the rest of your finances? In an ideal world, life insurance is only meant to provide for your family if you die unexpectedly. In this scenario, a term life policy that covers you until your kids are grown can be sufficient. You might take any money you save by purchasing a cheaper term life policy, investing it and using that money to help build an estate for your heirs.
- Is your future debt-free? When you die, your estate is responsible for settling any debts you owe. In order to ensure your heirs don’t inherit your debt, your assets need to cover what you owe. If you won’t have enough in retirement accounts or property, life insurance can help with this. For older folks, this may mean they need a whole life policy, so coverage doesn’t run out.
- Do you have long-term care insurance? If not, permanent policies may offer accelerated death benefits or ADBs. Morbid name aside, this option — which you may have to pay more for — can be helpful if any health issues arise in retirement. ADBs allow you to use a portion of the payout you’ve purchased to cover medical costs while you’re still alive, like those associated with a terminal illness or nursing home care. Keep in mind, Medicare rarely covers nursing home care, so you’ll need to pay for that out-of-pocket should you need it (unless you qualify for Medicaid). Some life insurance policies now bundle long-term care insurance more officially into the plan, so you won’t need to use ADBs.
If you have more questions about life insurance, I talk about it in more detail on my Minority Money podcast, episode 41. Or you can make an appointment to discuss your specific situation.