If you have a spouse or children, it’s time to consider a life insurance policy.
Life insurance policies can be complicated at best, unintelligible at worst.
Insurance companies are regulated on a state basis, which makes for different rules and regulations and more difficult comparisons.
A lot of people don't pay much attention to them because they get free or low-cost coverage through their employer. That's fine until you become unemployed or self employed and your insurance policy disappears.
So, here’s what you’ll need to know to get what you need to protect your loved ones, and avoid spending too much.
Term Vs. Whole
There are two basic types of life insurance: term and whole.
A useful analogy to explain the difference is buying versus renting. With term life insurance, you’re renting. It’s never really yours, and eventually your lease is up.
In contrast, you own a whole-life insurance policy, because the original policy amount must be returned to you. The monthly premiums are higher, but the money goes into a fund that grows over time. (For the cash-strapped or thrifty, there is a poor man's version called Universal life.)
The large majority of insurance policies are term-life. You pay for a certain number of years (20, 30, 40) for a certain amount of coverage $100, 000, $500,000, $ 1 million) and only received the benefit if you die while the policy is in place.
Whole life can be seen as a combination of insurance and investment.
Insurance specialist David Eidlitz of Northwestern Mutual recommends whole life policies simply because they are permanent.
“On a permanent whole life policy, you are investing into the general fund of the investment company. Once the money is there, it is no longer subject to risk. The mutual companies are owned by the policyholders, and they are not public. Given that there are no stockholders, mutual companies can hold their bonds to maturity,” he says.
The mutual companies Eidlitz is referring to include Guardian Life, New York Life, Mass Mutual, and Northwestern Mutual.
Policyholders earn interest on the money and sometimes small annual dividends, which vary by company, policy and the sum paid in, but offer low, single-digit returns that are attractive to conservative investors, who might otherwise prefer fixed income.
In that context, one of the main advantages to whole life policy is that the money you collect is tax-free, as opposed to other savings, investment and retirement vehicles, like a 401(k) plan.
You receive the money in one of two ways: the technical terms are death benefit and cash value, also known as . With the former, your designated loved one, the beneficiary, will receive the policy amount as a benefit upon your death. If you are still living and want to collect, you will be paid the policy's cash value.
Eidlitz explains how the death benefit works. "Say, you’ve set up a policy to pay out $100,000 today in 20 years. Your premium is fixed during that time. When you die, your family will get exactly $100,000. Cash value is different. You only get the cash value if you live. Cash value accumulates, and it is guaranteed to increase every year.”
Wondering what’s the catch? As with most investments, the whole life investment only makes sense at a specific life stage and income level. Here’s why: