The Basics of Life Insurance

While the primary purpose of purchasing a life insurance policy is to provide a financial safety net for your family and dependents in the event of death, life insurance is also an asset just like stocks, bonds, and real estate. There are instances where having insurance makes sense and times when it doesn’t. As a result, you should evaluate your coverage regularly to make sure that it complements your overall financial plan.

There are two types of life insurance: term and permanent.

Term life insurance policies are those in which you buy coverage for a defined period – usually 10-30 years. If you die during the term, the policy will pay the defined cash benefit to your beneficiary(s).

The advantage of term life insurance over permanent life insurance is that it is less expensive. Term life insurance is straightforward coverage with no added bells and whistles such as cash value or investment subaccounts. Under most circumstances, that is a good thing, and we frequently recommend term life insurance to individuals as both an asset replacement and time replacement strategy.

For example, when a family has one spouse working full-time while the other stays home with young children, term insurance may be a good idea for both the working and stay-at-home spouse. If the working spouse passes away, insurance can replace a significant amount of their future earnings potential and allow the family to manage things like pay off the mortgage, send children to college, and ensure the family’s financial stability. And, should the stay-at-home parent should pass away, insurance would policy would cover things such as the likely increase in childcare costs.

The downside to term insurance is that once the term period ends, the coverage only continues if you pay astronomical premiums. If someone still needs insurance after expiration, they’d need to buy a new policy and may or may not be insurable at that time. And, unfortunately, term policies get very expensive as people age.

Permanent life insurance, on the other hand, will not expire until death as long as sufficient premiums are paid, and the policy rewards a cash benefit much like term insurance. Additionally, permanent insurance policies build cash reserves using part of the premiums. These cash reserves can generate returns in a tax-deferred manner.

Permanent life insurance is substantially more expensive than term due to the cost of extended coverage and providing returns on the cash value. Also, many permanent life insurance policies include a surrender fee if you want to get to the cash value of your policy. That said, you can also let the coverage lapse without penalty.

In our experience, most people’s need for life insurance is not permanent. In fact, the need for life insurance usually ends by the time people retire with enough retirement savings and income to live on, and their children are financially independent. Therefore, it is rare that we recommend permanent life insurance coverage.

So, what are some situations where permanent life insurance makes sense?

One circumstance that may favor a permanent life insurance policy is when you are concentrated in illiquid assets like a closely held business, real estate, or mineral rights. In this case, the policy can provide liquidity for your beneficiaries to retain the illiquid asset and pay any applicable estate tax.

Another reason for permanent insurance is if you have a family history of medical problems that could make you uninsurable at a later age. Also, for very high net worth individuals who have maxed out retirement savings, and are in the highest tax bracket, a permanent life insurance policy can sometimes be used as an investment tool.

When managing your risks concerning insurance, some considerations go beyond life insurance. For example, what if you are injured to the point of being incapacitated or unable to continue to work? Disability insurance, often overlooked as an essential planning tool, would help you in these circumstances. Many people are under-insured for a future disability while being over-insured for premature death.

If you would like to talk to someone about whether or not you need insurance, or you need help finding an insurance agent, please reach out to us. Maybe you’re at the point where you don’t need life insurance, but your adult children who are raising young families do. In either case, we can help you sort through the coverage options alongside an independent insurance broker.