Personal Finance Friday - Life Insurance
Life insurance is a weird product because you pay for something that you theoretically don’t get unless you die. However, that is not entirely accurate. While you are alive, you get a small sense of comfort that if you should randomly pass away, your family would at least not be poverty stricken along with mourning for you. So in that regard, you actually do get some benefit now (in the form of peace of mind) from buying insurance.
The questions people usually have about life insurance are: what kind should I get and how much should you buy? Well that all depends on each individual’s situation but here are some general things to think about. First, insurance companies are notorious for making extremely complicated and convoluted products for people to buy, I’d generally stay away from those things. The two most well known and pretty easy to understand products are: whole life insurance and term life insurance.
The simplest and cleanest form of insurance is the term life insurance contract, it is a pure insurance product. The insurance company agrees to pay out a certain amount of money if you die within a certain window of time, nice and simple. And generally for people under 50 its pretty cheap. Like $50 a month for $1 million of coverage (sometimes much less).
Whole life is another product commonly purchased, whole life is a combination of an insurance product and investment product in one package. Basically you pay more than you would for a term life insurance product, and that extra amount is invested in the company providing the product. Over time, that extra amount grows and becomes a sizable portion of the value, towards the end of the contract almost all of the value is that extra invested amount, and it is no longer an insurance product, it is just a big savings account. There are some tax advantages to whole life, but in general I’d say that you should beware of whole life insurance. It is not necessarily a bad thing, but many times it is not a great thing either. It would more often than not be better if you just bought term life insurance and took the money you would have spent on whole life and just invested it.
Finally, how much insurance do you need? Well here is a rough rule of thumb to at least get an idea of about how much you might need. Take your household expenses each year, times them by 20. Then subtract any savings and investments that you might have, that is about how much would be needed to ensure your loved ones are pretty well taken care of. If you’re doing it right by time you are getting into your late 50’s and 60’s life insurance is no longer necessary because you will have enough money that your significant other can support themselves without a big payout from insurance. As you get older that insurance gets more and more expensive for obvious reasons, so the plan should be not to need it!