If you have a car, you have car insurance. If you have a home, you have homeowner\u2019s insurance. If you have a life . . . well, it only makes sense to carry life insurance, right?<\/p>\n\n\n\n
Life insurance is one of the most vital pieces of your family\u2019s long-term financial plan\u2014and it\u2019s the one we want to discuss the least. Its purpose is simple: to replace your income for your family if you die. But with all the choices available, finding a policy that\u2019s just right for you could lead to extreme confusion and frustration.<\/p>\n\n\n\n
Fortunately, it doesn\u2019t have to be that way. We\u2019ll take you through the most common life insurance policies and help you find the one you need.<\/p>\n\n\n\n
Term life insurance<\/a> is the simplest (and usually the most affordable) type of life insurance you can buy. That\u2019s because it\u2019s insurance that does one thing and one thing only: pays the people you choose\u2014your spouse, children, or other beneficiaries\u2014a fixed amount of money if you die. But a term life policy is not worth a thing unless you die during the course of the term. (We said it wasn\u2019t a fun thing to talk about.) The bottom line is, it\u2019s a way for you to proactively take care of your loved ones so they don\u2019t have to worry when you\u2019re gone.<\/p>\n\n\n\n Think of it like your car insurance. Every six months (or maybe every month), you write a check to your insurance company. They deposit your check. If you have a wreck, they pay the claim. But if you don\u2019t have a wreck? You don\u2019t expect a refund on your premiums just because you paid them to take on all the risk of that big, family road trip across the country.<\/p>\n\n\n\n With term life, you\u2019re paying the insurance company to assume the financial risk of your death during the period (or term<\/em>) of your policy. Typical terms are 10, 15, 20, or 30 years. So, if you buy a 15-year term life policy with $500,000 in coverage, you\u2019ll make a monthly payment for 15 years. If you die during that 15 years, the insurance company will write your family a check for $500,000, also known as the death benefit.<\/p>\n\n\n\n If you\u2019ve listened to Dave Ramsey for more than five minutes, you\u2019ve probably heard him say term life is the only life insurance policy you should get. We recommend you purchase a term life insurance policy for 10\u201312 times your annual income. That way, your income will be replaced if something happens to you. This is the cheapest way to protect your family long-term<\/a>. More on that later.<\/p>\n\n\n\n If term life is pretty easy to understand, permanent life insurance is where it gets really<\/em> complicated. That\u2019s in part because permanent life insurance is trying to do two things at once. It\u2019s trying to provide the benefits of life insurance\u2014paying your beneficiaries in the event of your death\u2014and trying to be an investment account at the same time.<\/p>\n\n\n\n A permanent life insurance policy includes something called \u201ccash value<\/a>.\u201d Think of cash value as a savings account you\u2019re depositing money into every month. It\u2019s a pool of money you own and can access or borrow against. The longer you have the policy, the more cash value the policy has.<\/p>\n\n\n\n Another major difference between permanent life and term life policies is that permanent life policies don\u2019t expire. They continue until you die or quit paying your premium.<\/p>\n\n\n\n The particulars of how much your family receives, how the cash value grows, and other questions depend a lot on the policy you purchase. Permanent life insurance policies can include whole life, universal life, or variable universal life.<\/p>\n\n\n\n When you purchase a whole life policy<\/a>, you lock in the premium amount for as long as you want the policy. Each month, you pay your premium to the insurance company. A portion of that premium goes into the cash value and grows over the whole life of the policy. Get it? Whole<\/em> life?<\/p>\n\n\n\n The longer you own the policy, the more cash value it has. It really is like a savings account. But remember, your life insurance has one job: to pay your beneficiaries if you die. Because whole life does this and<\/em> grows a cash value, you\u2019re usually paying more<\/em> for less<\/em> insurance.<\/p>\n\n\n\n That\u2019s why whole life insurance can be a lot more expensive than term life insurance. Worse still, whole life policies don\u2019t gain as much cash value as that extra amount you\u2019re paying would if it were invested in a good mutual fund. Does it make sense to spend more money for less coverage and a bad long-term investment? Hint: it doesn\u2019t.<\/p>\n\n\n\n Like a whole life policy, universal life insurance<\/a> has a death benefit and a cash value. But unlike whole life policies, universal life insurance policies offer adjustable premiums\u2014meaning you might be able to access some of the cash value to adjust your yearly payment. Either way, you\u2019re not off the hook for the minimum premium payment to maintain the policy. But you might<\/em> be able to eliminate a premium payment depending on how much potential cash value you have. Or, you might choose to leave things alone and possibly rack up some cash value over time.<\/p>\n\n\n\n Which leads us to the long-term investment \u201cstrategy\u201d of this type of policy. Basically, part of the monthly premium of a universal life policy goes toward the death benefit and another part is invested as \u201csavings.\u201d The thought is that the investment will grow with time\u2014and maybe even enough to offset the premiums all together.<\/p>\n\n\n\n But in reality, this is a bad<\/em> investment strategy. Why?<\/p>\n\n\n\n Two things:<\/p>\n\n\n\n An annual renewal term might help cover the increased risk of death as you get older, but that will be the only thing increasing\u2014definitely not your savings! You\u2019re better off getting a term life policy and investing in a mutual fund for a better return.<\/p>\n\n\n\n Remember how whole life and universal life policies are trying to do too many things at once? So are variable universal life policies. They just get more complicated! Variable universal life policies are trying to be a life insurance policy, a savings account, and a mutual fund all at one time. And that gets expensive<\/em>.<\/p>\n\n\n\n Variable universal life insurance allows you to decide how<\/em> your cash value is invested. As with a traditional mutual fund, there are dozens of risk levels of stocks and bonds you can choose. You\u2019re presented with a host of investment options for your cash value, and you get to pick how risky you are with those investments. That\u2019s the \u201cvariable\u201d part. However, it\u2019s key to remember that insurance is about risk and who assumes the risk.<\/p>\n\n\n\n Because you<\/em> are in control of where your money is invested, you<\/em> bear the risk of your investments\u2014not the insurance company. Variable universal life policies have no guarantees about how much the cash value of those policies will be.<\/p>\n\n\n\n Dave considers variable universal life policies to be one of the worst<\/em> life insurance options on the market because of the high management fees. (Are you seeing a fee trend here?) Again, you would be much better off getting a term life policy and putting your hard-earned money in mutual fund investments.<\/p>\n\n\n\n The two primary types of life insurance\u2014term life and permanent life\u2014are just the tip of the iceberg. Insurance companies also offer dozens of other insurance policies, each designed to pay death benefits in different ways. Here\u2019s a brief overview of the types of life insurance you may encounter when you\u2019re shopping around.<\/p>\n\n\n\n Joint life insurance, also called first-to-die insurance (yikes!), is a cash value policy marketed to couples who want to share a policy between them. Think of joint life insurance policies as the joint checking account of the life insurance world. The policy covers two individuals for one fee. These policies pay a death benefit as soon as the first spouse dies.<\/p>\n\n\n\n And there\u2019s the problem: if your finances are like most families, one spouse makes more than the other\u2014and sometimes a lot more. Remember, the job of life insurance is to replace someone\u2019s income in the event of their death. Joint life insurance takes a one-size-fits-all approach and pays out the same benefit to either spouse.<\/p>\n\n\n\n That means you could be paying a lot more to insure your spouse\u2019s part-time income from the local fabric store than you would if you were to simply buy two term life policies. A joint life policy doesn\u2019t make a whole lot of sense when you weigh the costs.<\/p>\n\n\n\n If joint life insurance policies don\u2019t make much sense, then survivorship or second-to-die insurance life policies are a complete waste of your money (and doubly hard to talk about). We recommend you avoid survivorship life policies altogether because a survivorship life policy, which is also a type of cash value policy, pays absolutely zero benefit to anyone until both spouses die<\/em>. Then, it pays your kids.<\/p>\n\n\n\n Survivorship policies are primarily geared toward wealthy people wanting to avoid large estate taxes on what they leave behind. They aren\u2019t really intended to cover your spouse at all. Plus, your spouse isn\u2019t covered when you<\/em> die. So yes, you guessed it. As with all cash value policies, here\u2019s the broken-record message: you and your spouse are better off getting a term life policy and then investing in a good mutual fund instead.<\/p>\n\n\n\n At first glance, final expense insurance (or burial insurance) seems to make sense because it\u2019s relatively cheap. Flashy advertisements will suggest you\u2019re sparing your family the burden of paying for your funeral. It\u2019s all about \u201cpeace of mind\u201d in knowing your funeral expenses are covered before you die, right?<\/p>\n\n\n\n But burial insurance, which is also a type of cash value insurance, is a completely emotional purchase that makes absolutely no sense financially. Your funeral is something you can plan to pay for<\/em> if you simply set aside $50 a month every month starting at age 55.<\/p>\n\n\n\n Let\u2019s say you live to the ripe age of 78 years old (the average lifespan in America). That\u2019s 23 years of socking away $50 a month or more than $13,000<\/em>\u2014and that\u2019s assuming you don\u2019t invest the money! If you invest it with your other savings and earn just 10% a year, you\u2019ll have saved almost $53,000<\/em>! Since the median cost of a funeral is around $7,000, why not just save up the money to pay for your own funeral and tell the insurance company to take a hike?<\/p>\n\n\n\n Applying for either a term or whole life policy in the past was kind of like trying out for a sports team\u2014you had to get a complete medical screening just to get started! We\u2019re talking blood draw, body weight, drug screening! But due to the pandemic this year, no medical exam policies<\/a> and touchless exams have become the norm. Top-shelf companies now offer this approach at the same rates as options that require a medical exam.<\/p>\n\n\n\n Decreasing term life insurance was designed to provide a death benefit that decreases in proportion with a decrease in your liabilities. Specific examples of this type of insurance include mortgage life and credit life insurance. In these examples, the death benefit is designed to follow the amortization schedule of a mortgage or other personal loan.<\/p>\n\n\n\n The policies are advertised as a way to settle debts or pay off your mortgage if you die. So really, it\u2019s just making payments on your debts\u2014and your beneficiaries don\u2019t get the full benefits of life insurance. In other words, they potentially inherit nothing more than a paid-off or paid-down debt, but no cash in their pocket. Like term life insurance, there is no cash value. Therefore, the final value is ZERO at the end of the term.<\/p>\n\n\n\n So, let\u2019s go back and take a look at that $500,000 term life policy example we mentioned above and apply it to real life. If you had a decreasing term life policy and died in the last month of the term, your family would get zero dollars.<\/p>\n\n\n\n So, here\u2019s the question: if life insurance is about protecting your family\u2019s long-term financial plan, how on earth can you plan<\/em> for something you don\u2019t know the value of? That\u2019s the problem with decreasing term life policies. You never know how much they\u2019re going to be worth when you die, so they provide your family very little financial security.<\/p>\n\n\n\n An accidental death and dismemberment policy, or AD&D, is one of those policies almost everyone has encountered at some point. The insurance agent tries to sell you an inexpensive policy that pays out in the event of your accidental death or dismemberment. If you lose an arm and can\u2019t work, it pays a portion of the benefit. If you die in an accident, it pays the full death benefit.<\/p>\n\n\n\n These policies are cheap\u2014usually just a few bucks a paycheck\u2014but you get what you pay for. Many AD&D policies will not pay a death benefit if you die from a medical procedure, a health-related issue, or a drug overdose. So as you get older, your chances of dying by accident are significantly reduced. That is why an AD&D policy is no substitute for\u2014wait for it\u2014a term life policy.<\/p>\n\n\n\n So, how much life insurance should you carry<\/a>?<\/p>\n\n\n\nPermanent Life Insurance<\/h2>\n\n\n\n
Whole Life Insurance<\/h2>\n\n\n\n
Universal Life Insurance<\/h2>\n\n\n\n
Variable Universal Life Insurance<\/h2>\n\n\n\n
Other Types of Life Insurance Policies<\/h2>\n\n\n\n
Joint Life (First-to-Die) Insurance<\/h3>\n\n\n\n
Survivorship (Second-to-Die) Life Insurance<\/h3>\n\n\n\n
Final Expense Insurance<\/h3>\n\n\n\n
No Medical Exam Insurance<\/h3>\n\n\n\n
Decreasing Term Life: Mortgage Life and Credit Life Insurance<\/h3>\n\n\n\n
Accidental Death and Dismemberment Insurance<\/h3>\n\n\n\n
Determine How Much Life Insurance You Need<\/h2>\n\n\n\n