Insurance paid to a beneficiary when the insured dies. Life insurance is designed to replace the deceased’s income. The death benefit amount is chosen by the individual and unfortunately most people are unsure of exactly how much they should buy. There are numerous “expert” opinions on how to calculate the amount your family will need in the event of your premature death but since we do not know when this will occur, how much debt you will have at the time, how much college will cost, and what inflation will be, the calculation is at best a guess. Instead, we have our clients think about what they would like their death benefit to provide their beneficiaries when they pass away. We use this list to begin our education of how much death benefit to purchase. Ideally everyone would insure 100% of the loss of their income: this amount is called the human life value. This is the maximum an insurance company will allow you to purchase. (If you are 30 years old and make $80,000 a year the insurance company would assume you could work another 20 years so your human life value would be approximately $1,600,000.)
Another important factor to consider is the type of insurance to buy. There are only two types: term which by definition is temporary insurance, and whole life which by definition is permanent insurance. (Another way to look at it is renting vs. owning.) All other types, universal, flexible premium…) are blends of term and whole life.
Term insurance starts off very inexpensive but the cost of term increases as you age. Therefore most individuals will pay for term all there lives and when they need it most (age 60+) the cost is so high that they end up dropping the policy. In this case they may have spent thousand of dollars and they will never receive a benefit. The best use of term insurance is for temporary coverage or until an individual can convert the term to whole life.
On the other hand, whole life starts out with a higher premium but the cost is fixed and will not increase. A portion of the premium is allocated to a savings component within the policy beginning as early as year 2 of the policy. This savings has a guaranteed rate of interest plus the possibility of dividends and can be used throughout the individual’s life for a number of things even to fund a child’s college education.
Most people have heard of the buy term and invest the premium difference between term and whole life strategy. This sounds good on the surface because initially term is so inexpensive but term costs will rise meaning less will be invested, and there is market risk that may cause the investment to lose money. Because of these factors, there are other strategies using whole life insurance that may create more protection and wealth especially if coordinated with other assets during the accumulation, distribution, and preservation phases of money.