Life Insurance - Do I Need It?
Do you have dependents? Do you have kids? Do you have a partner and a mortgage? If you answered “yes” to either one, then yes you do need life insurance. If you answered “no”, chances are that you don’t. Also, if you are just graduating and starting your career - avoid life insurance until you actually need some sort of protection.
What Is Life Insurance?
Imagine a family where both parents work and bring home money to pay for food, the house, clothes, and fun things. Imagine that neither one on their own can support the family. Now imagine something happens to one of these parents and they are no longer around.
Life insurance is like a promise from an insurance company. You pay the insurance company a small amount of money every month. In return, they promise that if something happens to you, they will give a big pile of money to your family. That money helps your family pay for things like the house, food, school, and other bills.
Life insurance is basically a financial safety net for the people who depend on you. If no one depends on your income, then you don’t need life insurance.
Common types of life insurance
The most common types of life insurance include:
- Term
- Permanent
Let’s quickly look at each type.
Term Life Insurance
This is the simplest and usually the cheapest option. You buy insurance for a specific period of time like 10 years, 20 years or 30 years.
If you die during that period, the insurance company pays your family the agreed amount. If you do not die during that period, the policy ends and nothing is paid out.
Term life insurance is popular because it is cheap, simple and only covers the years when people usually need protection the most like while raising children, while paying a mortgage, and while your family mainly depends on your income.
This is the type of insurance both my wife and I have. We got it when we got married and bought a home. We paid for insurance that is enough to cover a funeral, the mortgage and a bit of extra to take time off.
Permanent Life Insurance
Permanent insurance lasts your entire life as long as you keep paying. It also has an investment or savings component inside the policy. This is where things start to get more complicated. There are three common types - whole, universal and variable.
Whole Life Insurance
Whole life insurance combines two things - insurance and a built-in savings account. Part of your payment pays for insurance while another part goes into a cash value that slowly grows.
This cash value can sometimes be borrowed against. The policy is designed to last your entire life and eventually pay out.
Whole life is much more expensive than term insurance. Sometimes 5 to 10 times more expensive for the same coverage.
Universal Life Insurance
Universal life is similar to whole life but more flexible. It still has an insurance component and a savings component but you may be able to adjust the premium payments, coverage and investment allocation.
The cash value inside the policy may be invested in different funds. Because of this flexibility, it can be more complicated and harder to understand.
Variable Life Insurance
Variable life insurance takes the investment portion further. The savings part of the policy can be invested in things similar to mutual funds. That means the value can go up or down depending on the market. This adds more risk and potentially higher cost.
What Do I Need?
A common rule of thumb is:
- Use term life insurance for protection
- Use regular investments for wealth building
In other words - insurance protects against risk while investments build wealth. Trying to combine both in one product can sometimes make things unnecessarily expensive.
And “expensive” is the reason you see and hear so many companies and independent salespeople pushing permanent life insurance. The commissions on this product are high. Unless there is a specific tax reason to use permanent life insurance, stay away from it and from people pushing it.
