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Life Insurance: What kind should I buy?

Posted on | December 26, 2007 |


When buying insurance, there are often two important and confusing questions that need to be answered:

1. How Much Do I Need?
2. What Kind Should I Buy?

I’ve answered the question of “How Much” in a previous post that you can read here.

This post is dedicated solely to the second question: What kind of life insurance you Should buy.

At first glance, there seems to be many different types of life insurance: Term Life, Whole Life, Variable Life, Universal Life, and Universal Variable Life. But, there are really only two basic categories of life insurance: “Lump Sum” and “Cash Value” policies.

The only type in the “Lump Sum” category is term life insurance. Term life insurance is also the simplest and most cost effective type. This is sometimes referred to as “pure” life insurance, as it only pays a specific lump sum to the beneficiary at the time of the insured’s death.

This puts all other kinds of life insurance into the “Cash Value” category. These types pay a lump sum death benefit (same as term life), but also, as the name implies, carry a cash value. Part of the premium on these types of policies goes into a savings account or some other low-risk investment, so the premiums tend to be higher on cash value policies.

Now the single, most important thing to know about life insurance is this: the primary purpose of life insurance is to replace the income of the insured should the unthinkable happen.

Most experts recommend buying term life insurance and forgoing the whole life or universal life varieties. The reason is twofold:

1). It fulfills the purpose of life insurance.

2). It’s cheaper than all other kinds and allows for the greatest flexibility in your financial planning.

This second part is key. The thinking is basically that you should buy your life insurance to ensure an income stream for your beneficiaries if you should die prematurely (the single purpose of life insurance), and invest the difference in premium cost between the term and cash life policies in a separate investment vehicle that you control.

With the wealth of information on investing and the abundance of discount brokerage services, studies have shown that people earn more if they invest in lost cost investment vehicles (i.e.: low cost mutual funds, or index funds). Of course, the key is to follow through and invest the difference between the cost of the Term and Whole policies. The result will be that you’ll earn much more on your money without the high fees and commission of an insurance agent, but you’ll also have the power to decide what fits your risk tolerance and investment style. You’ll have greater freedom and reward, but greater responsibility as well.

This is a great time to buy life insurance. The mortality rates of adults in the U.S. have been falling steadily over the last decade and a half, and so have life insurance rates. Also, there are numerous online sources that allow users to compare life insurance rates and institutions so they can select the best offering for their money.

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