When my wife was going through her medical training, there was a stream of so-called advisors offering free advice to newly-minted doctors. After speaking to a few of them we soon realized they were all insurance agents who were selling complicated permanent or variable life insurance policies under the guise of helping young professionals get off on the right financial path. Their solution to almost every financial question involved a complicated insurance product. Most insurance salesmen are not like this, but almost all agents make their living through commissions and so there’s a perverse incentive to upsell you. There’s no shortage of life insurance options available, and certainly no shortage of agents eager to sell you any number of policies, but the reality is that basic term life insurance is probably the only type of policy that you really need (and it also happens to be the least complicated and least expensive).

Who needs life insurance?

If there is someone in your life who depends upon your current and future income for financial support, then you probably need life insurance to transfer the financial risk of an untimely death. The benefits of a life insurance policy can cover your family’s immediate financial needs in the wake of your death, replace lost income, repay debt, cover expenses, and provide for your family’s goals. While we often avoid thinking about our deaths, life insurance provides some peace of mind knowing that your loved one’s financial needs will still be met in your absence. For this reason, the birth of a first child is often the occasion for most people to obtain life insurance, but you may want it sooner if you have aging parents or family members who are likely to depend on you as well. There are also certain situations where life insurance is advisable for business partners or is required for taking out a loan.

What is Term Life Insurance?

Term life insurance protects a specified length of time (the term, typically between 10 to 30 years), and pays a specified benefit amount if you die within the term. Term policies provide the highest coverage amount (a.k.a. death benefit) for the lowest cost (premium) because they are temporary. If you outlive the term and don’t renew, congratulations! You’re still alive, but you’ll get nothing. There are several types of term insurance each has its uses, though Level Premium Term is usually the best for most people.

Level Premium Term

You pay the same fixed premium throughout the term and the death benefit does not change. To make the premium constant over the term of the policy, you’re paying a greater amount than your pure risk at the beginning of the policy to balance out the later years when your risk of death is substantially higher. For this reason, a level premium is not the cheapest policy to start but is the most common choice if you expect to keep the policy for the entire term, and is quite affordable if you purchase a policy in your 20s or 30s. Level premium term policies can typically be renewed at the end of the term, but the premiums will reset at a significantly higher level and will increase each year as your risk of death increases (essentially they become an Annually Renewable Term policy at that point, see below).

Annually Renewable Term

The death benefit does not change, but the premiums increase each year commensurate with your actual risk of death. ART policies are initially cheaper than level premium term policies but will likely be more expensive over time. Plus, many people end up deciding to discontinue their policy before the end of the term because of the rising premium, which may no longer fit the budget or may not feel like it’s worth it anymore. For this reason, ART policies are more appropriate for short-term insurance needs.

Decreasing Term

Premiums remain constant but the death benefit decreases over time, reducing to zero by the time the policy expires and is not renewable. This type of policy is probably the least common term policy and is generally purchased if the beneficiary’s needs will decrease over time such as paying off the mortgage or other debt (where the balances decline as payments are made over time)

What about whole-life policies?

For most families with kids, term life insurance is all you need. You typically need coverage through your children’s college years and to make sure your spouse can maintain his or her lifestyle if they no longer have your income to meet expenses and savings needs. As you approach retirement, if you have saved and invested appropriately throughout your working years, you likely don’t need as much insurance coverage (if any) and the premiums also start increasing exponentially at that age. Of course, there are reasons that you might need a permanent insurance policy such as whole life or universal life, but most people don’t need one. Permanent policies are significantly more expensive because they don’t expire and will payout the benefit amount upon the insured’s death, no matter when it occurs (as long as the premiums were paid).

How much insurance do I need?

There are several approaches to calculating how much insurance you may need, but given the number of variables involved, there’s no one size fits all answer. A simple benchmark that gives a reasonable answer is 12-18x your annual gross pay. This works well for younger families who are just starting to build their net worth. For more information, check out our post that digs into this very question here: How Much Life Insurance Do I Need? - by Colin Page

A final word on the importance of life insurance:

I’ve known too many individuals whose families were left in a significant bind by their unexpected death without sufficient life insurance. In addition to grieving the death of their loved one, their families had to face difficult financial realities like needing to sell their home, taking a significant step down in lifestyle, and making other difficult financial tradeoffs, all of which could have been eased by a simple, affordable term life policy.

I get it, this is an uncomfortable subject, but life insurance is one of the foundational pieces of a solid financial plan, and I guarantee you’ll feel a certain peace of mind once you’ve addressed it.