Not everyone needs life insurance. The first thing to do is make
sure you need it. Life insurance is really meant for your family
members or other dependents who rely on your earnings.
Why You Buy Life Insurance
You buy life insurance so that, if you die, your dependents can
live the same kind of life they live now. Strictly speaking,
then, life insurance is only a means of replacing your earnings
in your absence. If you don't have dependents (say, because
you're single) or you don't have earnings (say, because you're
retired), you don't need life insurance. Note that children
rarely need life insurance because they almost never have
dependents and other people don't rely on their earnings.
Life Insurance Comes in Two Flavors
If you do need life insurance, you should know that it comes in
two basic flavors: term insurance and cash-value insurance (also
called "whole life" insurance). Ninety-nine times out of 100,
what you want is term insurance.
Term Life is Simple to Buy and Understand
Term life insurance is simple, straightforward life insurance.
You pay an annual premium, and if you die, a lump sum is paid to
your beneficiaries. Term life insurance gets its name because
you buy the insurance for a specific term, such as 5, 10, or 15
years (and sometimes longer). At the end of the term, you can
renew your policy or get a different one. The big benefits of
term insurance are that it's cheap and it's simple.
Cash Value is Trickier
The other flavor of life insurance is cash-value insurance. Many
people are attracted to cash-value insurance because it
supposedly lets them keep some of the premiums they pay over the
years. After all, the reasoning goes, you pay for life insurance
for 20, 30, or 40 years, so you might as well get some of the
money back. With cash-value insurance, some of the premium money
is kept in an account that is yours to keep or borrow against.
This sounds great. The only problem is that cash-value insurance
usually isn't a very good investment, even if you hold the
policy for years and years. And it's a terrible investment if
you keep the policy for only a year or two. What's more, to
really analyze a cash-value insurance policy, you need to
perform a very sophisticated financial analysis. And this is, in
fact, the major problem with cash-value life insurance.
While perhaps a handful of good cash-value insurance policies
are available, many-- perhaps most--are terrible investments.
And to tell the good from the bad, you need a computer and the
financial skills to perform something called discounted
cash-flow analysis. If you do think you need cash-value
insurance, it probably makes sense to have a financial planner
perform this analysis for you. Obviously, this financial planner
should be a different person from the insurance agent selling
you the policy.
What's the bottom line? Cash-value insurance is much too complex
a financial product for most people to deal with. Note, too,
that any investment option that's tax-deductible--such as a
401(k), a 401(b), a deductible IRA, a SEP/IRA, or a Keogh
plan--is always a better investment than the investment portion
of a cash-value policy. For these two reasons, I strongly
encourage you to simplify your financial affairs and increase
your net worth by sticking with tax-deductible investments.
If you do decide to follow my advice and choose a term life
insurance policy, be sure that your policy is non-cancelable and
renewable. You want a policy that cannot be canceled under any
circumstances, including poor health. (You have no way of
knowing what your health will be like ten years from now.) And
you want to be able to renew the policy even if your health
deteriorates. (You don't want to go through a medical review
each time a term is up and you need to renew.)
About the author:
Seattle certified public
accountant & writer Stephen L. Nelson CPA has written more
than 150 books. His bestselling book is Qu Determining How Much
Life Insurance You Needicken for Dummies, which sold more than
1,000,000 copies. His books have sold more than 4,000,000 copies
in English and have been translated into more than a dozen other
languages.
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