Normal people don’t spend excessive time contemplating their demise. That said, the last column started a conversation on just this topic, covering the issue of who might need life insurance and how to figure out how much is needed. This column will address what kind of life insurance might meet your needs, should you need it.
First a review. The first step is to ask the question: I’m dead, now what? If the answer is someone you love needs money, then you have a need for life insurance. Step two is to determine how much is enough (there’s never too much), which can be accomplished by either putting a value to foregone future earnings or a more detailed determination of what it would take to support those who depend on you.
It is only then that we get to the third step, determining which type of insurance best suits your needs. Although the type of insurance comes third in the process of evaluating a life insurance need, it is the focus of many debates over life insurance and it often causes paralysis, or creates an excuse to do nothing. Not acquiring life insurance because of an inability to determine the kind is the equivalent of not eating because one can’t determine the perfect meal. At some point, it makes sense to simply pick a dish and meet your basic obligation to yourself.
The kind of insurance should always be a tertiary consideration to determining the need and amount. If one needs life insurance, taking action to purchase it is a moral decision, similar to securing a safe residence for one’s family. The particular type one acquires is a business decision, akin to deciding whether it’s best to rent or buy an apartment, condominium house or country estate.
So what are the choices?
There are two type of policies, let’s call them “If” policies and “When” policies, temporary and permanent, often known as term and permanent. One is not better than the others, just as a sedan is not better than a pickup truck. They are simply designed for different jobs.
Let’s start with term insurance—the “If” policies. Term is pure life insurance, a contract that is in force for a period of time or term, generally referenced to the period of time over which the premium payments are fixed. These contracts pay an income-tax free death benefit if the insured dies while the contract is in force. Most policies through work are term policies.
These policies offer no cash values or investment features. Since the probability of death is low for healthy people who are young, term insurance is inexpensive on a cash flow basis for young people. Term is generally appropriate to cover large temporary needs, such as replacing money for a child’s education, a spouse’s income should death occur before retirement assets have been amassed.
Permanent policies are designed to be, well, permanent. These are the “when” policies, as in they will pay an income-tax free benefit when the insured passes on. The varieties include whole life, universal life, and variable universal life.
These variations, while significant, are dwarfed by the similarities. Permanent policies combine an insurance feature with a cash accumulation account. The premiums may be level or variable, but in the early years they will generally be more expensive than term. They are, however, designed to remain in force and therefore pay a benefit at advanced ages. This makes it an appropriate choice to cover long term and permanent needs, such as replacing lost pension and social security income, providing for children with special needs, or providing money to pay estate taxes. Since they are designed to pay when one dies, they may end up significantly less expensive than term over their lifetime.
In the long run, the best investment is the investment that provides the right amount of money when it is needed the most. The best insurance is that which provides the appropriate benefit when it is needed. Sometimes the need is temporary, and therefore a term insurance solution is appropriate. Sometimes, it is permanent and requires a permanent solution.
The first step, in either case, is taking the time and making the effort, either by oneself or with a professional, to identify your needs and put dollar figures to them. After that, one makes the business decision as to what combination of insurance to use to meet those needs.