Not everyone needs life insurance. The first thing to do is make
sure you need it. Life insurance is really meant for your family members
or other dependents who rely on your earnings.
Why You Buy Life Insurance
You buy life insurance so that, if you die, your dependents can live
the same kind of life they live now. Strictly speaking, then, life
insurance is only a means of replacing your earnings in your absence. If
you dont have dependents (say, because youre single) or you dont have
earnings (say, because youre retired), you dont need life insurance.
Note that children rarely need life insurance because they almost never
have dependents and other people dont rely on their earnings.
Life Insurance Comes in Two Flavors
If you do need life insurance, you should know that it comes in two
basic flavors: term insurance and cash-value insurance (also called
whole life insurance). Ninety-nine times out of 100, what you want is
term insurance.
Term Life is Simple to Buy and Understand
Term life insurance is simple, straightforward life insurance. You
pay an annual premium, and if you die, a lump sum is paid to your
beneficiaries. Term life insurance gets its name because you buy the
insurance for a specific term, such as 5, 10, or 15 years (and sometimes
longer). At the end of the term, you can renew your policy or get a
different one. The big benefits of term insurance are that its cheap and
its simple.
Cash Value is Trickier
The other flavor of life insurance is cash-value insurance. Many
people are attracted to cash-value insurance because it supposedly lets
them keep some of the premiums they pay over the years. After all, the
reasoning goes, you pay for life insurance for 20, 30, or 40 years, so
you might as well get some of the money back. With cash-value insurance,
some of the premium money is kept in an account that is yours to keep
or borrow against.
This sounds great. The only problem is that cash-value insurance
usually isnt a very good investment, even if you hold the policy for
years and years. And its a terrible investment if you keep the policy
for only a year or two. Whats more, to really analyze a cash-value
insurance policy, you need to perform a very sophisticated financial
analysis. And this is, in fact, the major problem with cash-value life
insurance.
While perhaps a handful of good cash-value insurance policies are
available, many perhaps mostare terrible investments. And to tell the
good from the bad, you need a computer and the financial skills to
perform something called discounted cash-flow analysis. If you do think
you need cash-value insurance, it probably makes sense to have a
financial planner perform this analysis for you. Obviously, this
financial planner should be a different person from the insurance agent
selling you the policy.
Whats the bottom line? Cash-value insurance is much too complex a
financial product for most people to deal with. Note, too, that any
investment option thats tax-deductiblesuch as a 401(k), a 401(b), a
deductible IRA, a SEP/IRA, or a Keogh planis always a better investment
than the investment portion of a cash-value policy. For these two
reasons, I strongly encourage you to simplify your financial affairs and
increase your net worth by sticking with tax-deductible investments.
If you do decide to follow my advice and choose a term life insurance
policy, be sure that your policy is non-cancelable and renewable. You
want a policy that cannot be canceled under any circumstances, including
poor health. (You have no way of knowing what your health will be like
ten years from now.) And you want to be able to renew the policy even if
your health deteriorates. (You dont want to go through a medical review
each time a term is up and you need to renew.)
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