Life Insurance: Understanding the Basics

We promised more basics on insurance…so here it is!

There is so much written about life insurance these days: policies are bad, policies are good, “you should never” this and “you should always” that.

For most of us we end an insurance discussion with this thought: I don’t like it and I’m not going to think about it.

That’s exactly the wrong answer.

There are some truths about life insurance you should know before dismissing it:

  • If you have a family, insurance will help them with your final expenses (burial or cremation, cost of a rock & roll band, etc.)
  • If you have a home, insurance can pay the mortgage so your family can take their time waiting for the right buyer instead settling for a quick one who’s trying to underpay.
  • If you are interested in making sure your family, artistic or charitable institutions receive a legacy from you (and you don’t yet have money to provide it), insurance can be a cost-effective way of leaving money to others.

Because of these three scenarios, it’s better to understand how insurance works first before dismissing it.

We’ll start with the biggest question of all:

Do You Need It?

If none of the three situations listed above describes your situation, and you have enough money to cover final expenses, you probably don’t need life insurance.

However, if any of those three scenarios apply to you, then investigating life insurance policies may be a smart move.

I recommend that you start out learning about the types of insurance rather than begin by calling an agent. Some agents don’t offer every type of coverage, and if the one you need isn’t offered, you’ll end up with a poor fit.

Luckily, finding out what type is right for you isn’t as difficult as you might think.

Types of Life Insurance

There are three basic types of life insurance coverage:

  • Term
  • Whole Life
  • Universal Life

Term Life is easy to remember if you just think about the word “term.” This coverage lasts for a set amount of time (term). When it expires, you’ll have to apply again. There is no mechanism to make it last longer. It’s pure insurance.

Simply put, if you die during the term it pays. If not, you’re out the money you paid for the policy (called the premium).

Upside: Inexpensive when you’re young (little chance you’ll die)

Downside: Expensive when you’re older (insurance companies think you’ll die)

Best Fit: If you have children or want coverage until you’re able to “get your feet on the ground,” term life is probably for you.

Whole Life is also easy to remember if you re-read the name. Guess how long it’s guaranteed to last? You’ve got it…your whole life! Whole life insurance forces you to pay more every month than term so that the insurance company can still provide insurance when you’re older.

Upside: It’ll be there when you die, as long as you pay the insurance bill on time.

Downside: The extra money you pay (called a “cash value”) is guaranteed to make sure it’ll last forever, so it garners a low return…making you pay a lot more money into the policy.

Best Fit: If you need insurance forever and don’t want any guesswork (and you’re willing to pay the extra money for guarantees) this one’s for you.

Universal Life is a hybrid policy. Like a universal connector in electronics, it fits many applications. This type of insurance bundles term insurance and a savings account together. Every year the term insurance is priced based on your age…so the price increases. To counteract this, you place additional money into the savings account portion. In essence, you’re only buying enough insurance to make up the difference in money that you don’t yet have in savings. If you have a policy that pays $1,000 when you die and have $300 in savings, you’re buying $700 of insurance.

Upside: If you fund the savings portion generously, this can be much less expensive than whole life insurance and still last your entire life. The policy is flexible, allowing you to lower the death benefit later (rather than cashing in the policy and buying a new one).

Downside: Did you understand my explanation of universal life above? If the answer is no, sadly this is the same for many agents who sell it. If the savings account isn’t adequately funded (a common problem), this is much more expensive than term and could run out of money right when you need it most.

Best Fit: This type works well for someone willing to learn how this policy works “under the hood” and who needs insurance for a long period of time, but in decreasing amounts. If you have children or large expenses that’ll still need to be paid when you die, and think you’ll still need insurance after they’re gone, this might be for you.

A Final Thought on Life Insurance

Many artists are wrapped up in the “now,” creating for today rather than for years down the road. Life insurance forces you to think long term. Are you going to need it for a long period of time? How you answer this question will help you decide which type is best. Hopefully, if you do shop for life insurance, you’ll know the basic three types before meeting with a salesperson. That way you’ll ensure they sell the type that best fits your needs.

Your Homework: Read our piece from the beginning of last month: Do I Need Insurance. This will help you avoid buying insurance you don’t need.