Life Insurance Basics

By Heidi St. Jean The main reason for life insurance is to provide income replacement to your beneficiaries if you die. But if you are interested in estate planning, cash accumulation, wealth transfer, and estate tax liquidity, life insurance can also help you achieve these goals. Life insurance policies are now available from more than 2,000 life insurance companies in the U.S., as well as from financial institutions that are now getting into the marketplace. Because it's just as important to understand the companies behind the products as it is to understand the products themselves, Insure.com carries company ratings from Standard & Poor's and Duff & Phelps to help you monitor the financial strength of individual insurers. This is especially important when you're buying life insurance, because policies will probably pay out many years from now, maybe even decades from now. Therefore, you'll want to know whether the company you're buying from will be solvent down the road. Assessing your life insurance needs To determine how much coverage you need, you can check out our coverage worksheet and learn what to ask your agent. The main types of life insurance on the market today fall into two categories: term and permanent. Put simply, term life insurance provides death-benefit protection for a specified period of time (for instance, you might buy a policy that has to be renewed in two years). Generally speaking, if you're looking for coverage for a short period of time, term life makes more sense. But if you are looking to have a policy for the rest of your life, or have investment goals, permanent insurance is a better fit. All life insurance policies will require that you meet certain medical criteria. TERM LIFE INSURANCE Non-Guaranteed Term Life Non-Guaranteed term life provides coverage only for a short time (usually a year) and is pure death-benefit protection. The risk with term life is that your health might deteriorate and you could be unable to get another policy once the term is up. Premiums can also increase dramatically as you age, but term life insurance is usually a good choice for young people who can't afford the higher expense of permanent insurance, or for people covering specific needs that will disappear in time, such as a car loan or a mortgage. Yearly Renewable and Convertible Term Yearly renewable term insurance offers a longer term, usually for five, 10, or 20 years. By buying a longer term policy, your costs can be stretched out to avoid the annual increases found in non-guaranteed term life. Convertible term is like yearly renewable term but it also offers conversion to a permanent policy in the future — when regular term premiums might become cost-prohibitive or if your health declines. Convertible term policies usually provide the maximum protection with the smallest amount of cash outlay required. This is a good choice especially for young people who are unable to afford the higher cost of permanent insurance right now but need maximum life insurance and also want to have the option of converting to permanent coverage in the future. PERMANENT LIFE INSURANCE Whole Life or Ordinary Life Similar to yearly renewable term and convertible term, whole life policies stretch the cost of insurance out over a longer period of time in order to level out the otherwise increasing cost of insurance. In this case, however, it is spread not over a few years but over your entire life. Your excess premium dollars are invested in the company's general portfolio. Because you aren't personally managing that investment, your selection of an insurance company is vitally important. With this type of policy, however, the inflexibility of premium payments could become a burden if your expenses increase or if you lose your job. Universal Life This option offers greater flexibility than whole or term life. After your initial payment, you can reduce or increase the amount of your death benefit (although to increase the amount, you'll probably have to give the insurance company medical proof that you are still in good health). Also, after your initial payment, you can pay premiums any time, in almost any amount within the policy's required minimums and maximums. You will need to actively manage these policies to maintain sufficient funding, especially because the insurance company can increase charges (like mortality and expenses). Plus, part of your premium is invested by your insurance company, so you'll need to be careful when choosing a company.