Want to know the truth about what kind of life insurance you should buy and how much you should buy? Stephen L. Nelson, a CPA and best-selling author, gives some advice.
Life insurance is not for everyone. First, you should make sure you really need it. Life insurance is really for your family or other people who depend on your income and can't survive without you.
Why You Should Buy Life Insurance
You buy life insurance so that if you die, the people who depend on you can keep living the way they do now. So, strictly speaking, life insurance is just a way to replace the money you would have earned if you were still alive. You don't need life insurance if you don't have anyone who depends on you (for example, if you're single) or if you don't make money (for example, if you're retired). Note that children almost never need life insurance because they don't have anyone who depends on them and no one depends on what they earn.
There are two kinds of life insurance.
If you do need life insurance, you should know that there are two main types: term insurance and cash-value insurance (also called "whole life" insurance). Term insurance is what you need 99 times out of 100.
Term life insurance is easy to buy and understand.
Term life insurance is simple and easy to understand. You pay an annual premium, and when you die, your beneficiaries get a lump sum. Term life insurance gets its name from the fact that you buy it for a set amount of time, like 5, 10, or 15 years (and sometimes longer). At the end of the policy's term, you can either renew it or get a new one. Term insurance is great because it is cheap and easy to understand.
Cash value is harder to figure out.
The other kind of life insurance is one that builds up cash value. Cash-value insurance is appealing to a lot of people because it lets them keep some of the premiums they've paid over the years. Since you pay for life insurance for 20, 30, or 40 years, the thinking goes, you might as well get some of that money back. With cash-value insurance, a portion of your premium is put into an account that you can use to pay for other things or borrow money from.
This is a great idea. The only problem is that cash-value insurance isn't usually a good investment, even if you keep the policy for a long time. And if you only keep the policy for a year or two, it's a terrible investment. Also, you need to do a very complex financial analysis to really understand how a cash-value insurance policy works. And this is the main problem with life insurance that builds cash value.
There may be a few good cash-value insurance policies, but many, or even most, of them are terrible investments. And to figure out which ones are good and which ones are bad, you need a computer and some knowledge of money to do something called discounted cash-flow analysis. If you do think you need cash-value insurance, it might make sense to have a financial planner do this analysis for you. Obviously, this financial planner shouldn't be the same person who sells you the insurance policy.
What does it all come down to? Cash-value insurance is a financial product that is too hard for most people to understand. Note that the investment part of a cash-value policy is always a worse investment than any tax-deductible investment option, such as a 401(k), 401(b), deductible IRA, SEP/IRA, or Keogh plan. Because of these two things, I really want you to keep your investments that don't cost you taxes and keep things simple with your money.
If you decide to take my advice and get term life insurance, make sure your policy can't be cancelled and can be renewed. You want a policy that can't be cancelled for any reason, even if your health gets worse. (You can't predict what your health will be like in ten years.) And you want to be able to renew the policy even if your health gets worse. (You don't want to have a medical checkup every time your term ends and you need to renew.)
