Life insurance is one piece of insurance that most people don’t want to think about. Losing a family member is one of the most devastating events a person can endure. The last thing you want to worry about when you’ve lost a member of your household is how you’re going to make up their income. This is where life insurance takes over. Everyone owes it to their family to research and obtain a life insurance policy for everyone bringing in an income.
How does life insurance work?
Life insurance is a contract between a policy holder and an insurance company where the insurance company pays a lump sum (in most cases) of money to the policy holder if a covered individual loses their life in one of the ways described in the policy. Typically, this means that the death must be “accidental” and not suicide.
What types of life insurance exist?
There are two main types of life insurance policies: protection policies and investment policies.
- Protection policies work much like the example described above, where a lump sum of money is given to the policy holder upon the death of an individual.
- Investment policies (cash-value) take life insurance a step further and pursue a growth of capital during the duration of the policy.
What type of policy do you recommend?
I recommend a type of protection policy called “term life insurance.” Term life insurance is much more affordable than that of an investment policy such as whole, universal, or variable life. It is my belief that investments should not be done within an insurance policy. The return on your money will be much lower than what you can achieve within mutual funds in the stock market. Therefore, I recommend buying term life insurance and investing the money into good mutual funds that you would have spent on an investment policy.
Investment policies are pushed by many insurance brokers because of the high commission associated with them. Here is an example from an article Dave Ramsey wrote regarding the difference between a protection policy (term) and an investment policy (cash-value):
If a 30-year-old man has $100 per month to spend on life insurance and shops the top five cash value companies, he will find he can purchase an average of $125,000 in insurance for his family. The pitch is to get a policy that will build up savings for retirement, which is what a cash value policy does. However, if this same guy purchases 20-year-level term insurance with coverage of $125,000, the cost will be only $7 per month, not $100.
WOW! If he goes with the cash value option, the other $93 per month should be in savings, right? Well, not really; you see, there are expenses.
Expenses? How much?
All of the $93 per month disappears in commissions and expenses for the first three years. After that, the return will average 2.6% per year for whole life, 4.2% for universal life, and 7.4% for the new-and-improved variable life policy that includes mutual funds, according to Consumer Federation of America, Kiplinger’s Personal Finance andFortune magazines. The same mutual funds outside of the policy average 12%.
Dave has a great point here. It would be wise to invest money outside of your life insurance policy so that you can get higher returns. I’ve talked with insurance agents who have argued that a cash-value insurance policy would force a person to save. True, but if you were to die before your term was up, you would only get back what the policy covers . . . your cash-value would be lost! Besides, you’re not a lazy person anyway. You’re reading this article, aren’t you? Chances are you are a person who is planning for the future and wouldn’t be caught years down the road having invested nothing and saved no money. You’re a person of action! You can obtain the willpower to intentionally save and invest, you don’t need someone to require it of you. A little self-control will reap numerous rewards.
Okay, so how much coverage of term life insurance should I have?
The good news is that term life insurance is very inexpensive. We’re talking less than it costs to eat out at a fancy restaurant once a month. A policy of $500,000 for both my wife and I on a 20-year term only costs $47/month. If we were to get $250,000 of coverage on a 20-year term it would cost $30/month. Keep in mind that we are relatively young, but the difference of premium if you are more “advanced in years” is not much.
A good rule of thumb for the coverage amount you need is 8-10 times your income level. Remember that the purpose of life insurance is to cover a person’s income if they were to die. 8-10% of your income invested into mutual funds should average a 12% return year-to-year, from which you can take out 6-8% to cover the loss of income (4-6% for inflation and taxes).
It is a good idea to anticipate a raise in income if you think you’ll be advancing within your company or pursuing more money actively and bring your coverage up to the amount you can afford for a given premium. For example, to raise my coverage from $250,000 to $500,000 on a 20-year term; it only costs $133 more a year. That’s a huge value!
How many years of coverage should I have with term life insurance?
If you have an action plan for getting out of debt, building a solid emergency fund, and investing money, you need to ask yourself this question:
How old will I be when I have a decent amount of savings and assets where I wouldn’t need to make up the difference from an income loss?
For example, if in the future when you are 50 years old (for those of you who are younger now), have your home paid for, have 3-6 months of expenses saved in an emergency fund, and have enough in investments to provide profit for the rest of your life, if your spouse were to die, you probably wouldn’t need to worry about having life insurance support you. So if you’re 30 years old now, consider getting 20-year term life insurance. By the time your term is up, you’ll be financially prepared for the rest of your life.
If you’re older, you need to ask yourself the same question but with a different age range in mind. When will you be financially secure? How long will it take you to get there? That’s how much term life insurance you need.
God calls us to be wise with our money. Having life insurance is part of that game plan if you couldn’t afford losing another person’s income. It’s so inexpensive, there’s no reason for you not to have it.
Go get some term life insurance, and whatever you do, stay away from cash-value life insurance!
“Insurance Essentials: Life Insurance” is part of a series on Insurance Essentials: An Introduction To Insurance You Need! I encourage you to read more articles on insurance. I’d also appreciate your comments below so that I might improve this article accordingly. Thank you for your help!
! John wrote two articles for the book: "Budgeting for Groceries" and "How Grocery Stores Work."
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Thanks for the article, but I have a quick question:
If I were to pass away, I would want to make sure that my wife and children will be okay. Since my wife is not as financially savvy, I would like to leave instructions for her of what to do if I pass away. Where do I tell her to invest the money to receive a 12% annual return to make sure that my income continues when I die?
Hi Jon. No doubt, the stock market can be a scary place for those who have never invested before. I would advise her to wait a year after your passing to make any big financial decisions. After a year, she needs to sit down with several (3 or more) brokers and find someone with a heart for teaching her about investments. Once she has found this person, she needs to make the requirements that the broker must follow to keep her portfolio. The broker should only be allowed to invest in mutual funds that have 5 to 10 year track records averaging 12% or more per year. A seasoned broker shouldn’t have a problem finding these kinds of returns. Hope that helps!
Which life insurance company would you recommend?
Pros and cons about having whole life insurance with the return of premium?
What you would say about Fixed index annuity from Security Benefit?
Thanks for the article.
The Lord bless you all. Maranatha.
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