The Basics of Life Insurance

The Basics of Life Insurance The purpose of life insurance is to do one thing, and that is to replace the income of the breadwinner if he or she should die prematurely. A premature death means that the person in question still has financial responsibilities such as a mortgage, raising a family, and having dependents.

Life insurance is the foundation for every financial plan. You may have a great investment program going for you, and may very well be on your way to debt freedom; but if you should die before you retire then your savings plan immediately stops. Life insurance is meant to fill that void if it should occur so your plans are still carried out after your death and your dependents are taken care of.

Life insurance falls into two basic categories:
  1. Term
  2. Whole Life
This goal of this article is to discuss the basic differences between the two types, and to help you decide what type of policy is best for your needs.

Term Insurance
Term life insurance is pure insurance. There are no "bells & whistles" to this type of insurance and it is the most affordable form of life insurance. Term protection covers you for a specific period of time, anywhere from 10 years to 30 years. The forms of Term insurance include Annual Renewable Term, Decreasing Term, Increasing Term and Level Term (the most popular form).

Whole Life Insurance
Whole life insurance is a bundled product. It combines insurance with a cash value accumulation component. Because of this accumulation feature, it is the most expensive type of life insurance. Whole life insurance is a permanent product and usually expires when the policyholder reaches age 100. Whole life or 'permanent' insurance comes in many different varieties, including Whole Life, Modified Life, Universal Life (a.k.a. Flexible Premium Life), Variable Life and Variable Universal Life (the most popular form). The following is an "apples to apples" comparison of the two.

Term Insurance Whole Life Insurance
Average cost per $1,000 $2.96 $13.82
Cash Accumulation No Yes
Coverage Last 10 years to 30 years Permanent (age 100)
Borrow $$$ No Yes (at 6-8% interest)
Death Benefit goes to Beneficiaries Beneficiaries (but not the cash value)

Consumer advocates have long advised buying cheaper level term insurance and investing more of your money into mutual funds that are held in IRAs; preferably a Roth IRA if you qualify for one. This concept, which is known as 'split funding', can be more beneficial to the consumer. Term buys you the most insurance dollar for dollar. Stock mutual funds (which historically have averaged 12.53% over the last 30 years), when held in IRAs and while using a systematic investment program will give you far greater returns with lower fees than even the most sophisticated whole life polices. The point: You are better off renting an estate while you build one. 'Split funding' may be the way to go for most people.

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