You’ve probably heard that you need life insurance but aren’t quite sure what it is, what the pros and cons are, or where to start. Luckily, you’re in the right place.
Life insurance is an important aspect of a complete financial plan – up there with emergency savings, retirement contributions and paying off debt. For most people, helping to financially protect loved ones in the event of premature death is crucial importance. And, the best part? It doesn’t have to be expensive.
Sometimes, life insurance can be confusing. So today, we’re breaking down exactly what life insurance is and how it works.
How does life insurance work?
Life insurance is a contract with an insurance company that helps financially protect your family if you pass away. You pay your life insurance premiums, and, if you pass away while coverage is in place, the life insurance company pays a lump sum (called a death benefit) to the beneficiary or beneficiaries you designate.
Depending on how your beneficiaries choose to use it, the life insurance policy’s death benefit can help them pay for things like funeral costs, help meet the costs of day-to-day living or be put toward future expenses.
Do I need life insurance?
Most likely. Most of us do.
The majority of adults need life insurance to help pay for debts like a mortgage or student loan, help replace lost income if you’re married or have children, to offer some stability to your company if you’re a business owner, or to provide a safety net for other dependents. It can also be a nice thing to help relieve financial stress on your loved ones during an already difficult time.
The question you have to ask yourself is whether or not you have people who rely on you financially. If the answer is yes, then you most likely need life insurance.
Common types of life insurance
Three common types of life insurance are term, whole and universal.
Term life insurance
Term life insurance provides coverage over a certain period of time (the coverage term), usually 10, 15, 20, 25, or 30 years, for a fixed monthly premium. If you pass away after this period and you have not extended your coverage, your beneficiaries will not receive payment. This type of insurance is usually an affordable option and provides a layer of financial protection in the years it may most be needed – while raising chlidren, or for the number of years of your mortgage obligation, for example.
Whole life insurance
Whole life insurance is permanent insurance, which means that it provides coverage for life, no matter how long you live, as long as you pay your life insurance premiums on time. It also includes a growing cash value on a tax-deferred basis that can increase your beneficiary’s ultimate payout over time and provide a cash value amount you can borrow against. Bear in mind, however, that access to cash values through borrowing or partial surrenders will reduce the policy’s cash value and death benefit, increase the chance that the policy will lapse, and may result in a tax liability if the policy terminates before you die.. Permanent life insurance policies are significantly more expensive than term life insurance, but the additional features can appeal to those who foresee a need for coverage over their entire lifetime.
Universal life insurance
Like whole life, universal life insurance is another type of permanent insurance, meaning it is designed to last one’s entire lifetime and offers flexibility so that you can, within certain limits, decide how much premium to pay (as long as there is enough value in your policy to cover the cost of insurance and administrative costs). Sometimes known as “adjustable life insurance,” you have the choice between a fixed death benefit, like term life, or an increasing one similar to whole life insurance. You can also change premium amounts, adjust your coverage amount, or use the cash value to help pay your life insurance premiums.
Which type of life insurance is right for me?
For people looking to put an adequate amount of coverage in place affordably, term life insurance is often a sound choice. Term life insurance offers you options so you can choose a coverage term (10, 15, 20 or 30 years) for when you may need it the most – like while your children are young or while you are still paying off your home and saving for retirement. You might be surprised to learn, for example, that a 35-year-old man in excellent health could get a 20-year, $500,000 Haven Term policy, issued by MassMutual, starting at $23.34 per month.
More expensive permanent life insurance policies — like whole and universal — can be cost-prohibitive for some or may result in people purchasing less coverage in order for the premium pricing to fit into their budget. However, for those who want lifetime coverage and can afford higher life insurance premiums, these cash value policies can accumulate money that can be used however you want.
How much life insurance do I need?
A common rule-of-thumb is that you should have life insurance coverage equal to 5 to 10 times your annual salary. But while that is a good starting point, the exact amount of life insurance coverage you need depends on your personal circumstances.
If you have a large mortgage or you want to provide for your kids’ college education, you might need a larger policy, and perhaps a longer term. Alternatively, if you’re a stay-at-home parent, a multiple of your annual salary may not be enough. You’ll need to consider what expenses your spouse might need to pay in your absence, like childcare and home upkeep.
However, these answers only tackle the coverage amount. If you are considering term life insurance, the duration for your coverage term is another consideration.
Typically, people select a term for the time period when they think they’ll need coverage the most, such as until your children are out of the house, when large debts will be paid off, or until you plan to be self-insured through retirement and other savings.
The easiest way to make sure you have the right amount of coverage for you is to use an online life insurance calculator to get a personalized recommendation.
How much does life insurance cost?
Life insurance policies are priced based on the amount of coverage you want, type of coverage, the length of that coverage and what the insurance company sees as your risk of death during the coverage period. Usually, a term life policy will be the most affordable option.
For example, a 35-year-old woman in excellent health can buy a 30-year, $500,000 Haven Term policy starting at $35.40 per month. A 20-year term for that same woman starts at $20.32 per month. You can get a sample quote for your coverage needs here.
When determining your pricing, one of the most important factors is your current health. In addition to your current health, your medical history, family medical history, lifestyle choices and income are also considered. Smokers, for instance, will pay significantly more for life insurance than nonsmokers. People with very high-risk hobbies, like BASE jumping, might not be able to get coverage at all.
Once you are approved for coverage, you must make regular payments to keep your contract active. Health issues that arise after your policy is in effect can’t change the price or terms of your policy.
Remember: The best life insurance pricing is usually achieved the younger and healthier you are. So, if you know you need coverage, the best time to buy it is now. Plus, today’s life insurance is cheaper than ever before.
How to get life insurance
You’ll fill out a brief form about you, including your gender, age, weight, whether or not you smoke and some other medical history. Then, you’ll receive an instant decision on if you’re eligible. In some cases, you will not need to take a medical exam, so you could have your final rate and coverage started immediately. (Keep in mind: It’s very important to be honest when completing the application. The issuance of the policy or payment of benefits may depend upon the answers given in the application and their truthfulness.)
If a medical exam is needed, you can take it at a time and place of your convenience. At Haven Life, we aim to make taking a medical exam as simple as possible. A trained paramedic will come to a place of your choosing. You can expect him or her to review your family’s medical history, measure your blood pressure, height and weight, and collect blood and urine samples.
Life insurance for your peace of mind
With an intangible product like life insurance, it’s easy to question if it’s worth it. The answer, though: absolutely.
While there’s no monetary value you can put on peace of mind, for many, knowing you have financial protection in place for your family is everything.
Chelsea Brennan is the founder of Smart Money Mamas, a personal finance blog that focuses on family finance, investing and reducing money stress. Chelsea is an ex-hedge fund investor whose work has appeared in a wide array of publications, including Forbes, Business Insider and more. Opinions are her own.