Life insurance made simple

Many people avoid buying life insurance for two primary reasons:

  1. It’s not fun to think about dying.
  2. Life insurance is confusing!

This article is designed to help you past those hurdles so you can tackle life insurance head on. After all, death is a “when,” not “if,” situation, so you might as well plan for it.

What is life insurance?

When you buy life insurance, you’re buying a promise that upon your death, the insurance company will pay a certain amount of money to the people you choose. The money that’s paid is called a death benefit, and the people who receive it are called beneficiaries. You can have one or more beneficiaries, and you can choose a person (like your spouse) or an entity (like a trust) to be your beneficiary.

Why is life insurance important?

If you die, your income stops, too. However, living expenses for anyone who depends on you will continue. A life insurance benefit is designed to help replace your income and enable the loved ones you leave behind to continue meeting their financial obligations and living comfortably. As unpleasant as it is to think about your death, it’s probably even more unpleasant to think about those you love struggling financially without you.

What types of life insurance are there?

There are two primary types of life insurance — term and permanent

  • Term life insurance provides coverage for a certain length of time. For example, you could buy a 10-year, 15-year, 20-year, or longer term. If you die within the covered term, your beneficiary receives the death benefit. However, if you’re still alive when the term ends, your coverage ends, too. Company-paid basic life insurance is known as group term life insurance, with the “term” being the length of your employment. Supplemental options for employee-paid life insurance are often term policies as well, but sometimes permanent life insurance options are available.
  • Permanent life insurance provides coverage that stays in place your entire life. It’s more expensive because your beneficiaries are guaranteed a death benefit no matter when you die (as long as you’ve kept up with your premiums). Permanent life insurance also offers a cash value component, which you can withdraw or borrow against while you’re still alive. There are many different kinds of permanent life insurance. Here are a few:
    • Whole life insurance is the most common type of permanent life insurance. It offers lifelong coverage and level premiums that stay the same for the life of the policy. Your cash value account, funded by a portion of your premiums, earns a fixed rate of return.
    • Universal life insurance is similar to whole life insurance, but offers more flexibility. You can change the amount you pay in premiums, by either adding to or withdrawing from your cash account. The rate of return your cash account earns may change over time, as may the cost of your coverage. And, you may also have the flexibility to adjust the death benefit amount.
    • Variable universal life insurance is similar to universal life insurance but adds an investment component. Your cash value account can be invested in subaccounts, which offer the potential for higher returns, but also bring added risk. If your investments do well, you could increase the death benefit payable to your beneficiaries, but that’s not guaranteed.

Which type of life insurance is right for you?

Deciding on the right life insurance really depends on your goals, budget, and financial savvy. Consider these scenarios:

Scenario 1: Term life insurance to provide basic financial protection

If you’re married, own a home, and have young children, you might want a term policy with a big enough death benefit that would pay off the mortgage, pay for college, and provide a cushion for living expenses to help keep your family financially secure if you died. With term life insurance, you get affordable coverage when you really need it — ideally until your kids are grown and major expenses are out of the way.

Scenario 2: Whole life insurance to leave an inheritance

If you want to provide a financial gift to heirs or fund a trust upon your death (at whatever age that may be), permanent life insurance ensures a death benefit will be paid when you die. Whole life insurance is the most straightforward type of permanent life insurance.

Scenario 3: Variable universal life insurance to invest with flexibility

If you’re an experienced investor comfortable with risk and plan to closely manage your policy, variable universal life insurance may be a good fit. You’ll have lifelong coverage, a choice of investments, flexible premium payments, and a flexible death benefit that can be used in different ways.

How much life insurance do you need?

There’s no magic formula to determine the amount of life insurance to buy. The right coverage depends on your situation and goals. Consider the financial obligations your loved ones would face if you died and were no longer earning an income. Think about both everyday living expenses as well as existing and future debts, like a mortgage or college expenses, as well as health care and funeral costs. If you can’t afford the ideal coverage, start with an amount you can afford — some protection is better than none.

Terms to know

It’s important to understand these terms as you explore your life insurance options:

  • Group life insurance – Company-paid basic life insurance is typically group term life insurance. This means your coverage lasts throughout your employment but ends if you leave the company. Supplemental options for employee-paid life insurance (for you and other members of your family) are often group term policies as well, but sometimes permanent life insurance (such as group universal life insurance) is available. If you enroll in group supplemental life insurance through your company benefits program, you may have the option to convert it to an individual policy upon leaving the company in order to continue your coverage.
  • Evidence of insurability (EOI) – If EOI is required, you will need to provide information about your health before being approved for life insurance coverage.
  • Guaranteed issue – In some cases, like when you first become eligible for company benefits, life insurance may be offered at guaranteed issue. This means that no EOI is required — you’re automatically approved for coverage up to a certain amount without providing information about your health.
  • Rider – Some life insurance policies offer one or more riders, which add to or modify the coverage provided by the main policy. Riders can also be referred to as endorsements.
  • Underwriting – Life insurance underwriting evaluates an applicant’s insurability based on things like age, health, lifestyle, occupation, family medical history, etc.
  • Accidental Death & Dismemberment (AD&D) insurance – AD&D insurance is similar to life insurance but is a separate policy that pays benefits (in addition to any life insurance benefits that may apply) should you lose your life, sight, hearing, speech, or use of your limb(s) in an accident. AD&D benefits are paid as a percentage of your coverage amount — from 50% to 100% — depending on the type of loss. There are no EOI requirements for AD&D insurance.