The purpose of life insurance is to replace income in the event of an untimely death. Nobody wants to leave their family in the lurch with lots of debt and inadequate income. Life insurance provides a guarantee that your family will be taken care of in the event anything happens to you.

How does Life Insurance Work?

Life insurance pays a death benefit to your beneficiary in the event of your death. The primary purpose of life insurance is to replace your earnings to help your loved ones go on living. 

There are two main types of life insurance, term life and whole life. They share one common trait: once the policy is written, the premiums never go up. That is unique to life insurance, other forms of insurance such as long-term care and home and auto coverage are notorious for raising premiums.

Types of Life Insurance

Term Life is the simplest and least expensive type of life insurance. It’s no coincidence that it’s also the most popular. As the name implies, term life provides coverage for a specific term, such as 20 or 30 years. When the term expires, the premiums cease and so does the coverage.

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Why does term life insurance come with an expiration date? Because by the time most people reach the end of the term, they have accumulated other assets which can be used to cover living expenses, and their family responsibilities have diminished. That is, your children are on their own and self-sufficient. Term life is timed to expire about the time you no longer need it.

Whole Life provides life insurance with the added benefit of a cash value. The longer you own the policy, the greater the cash value. The cash value grows at a guaranteed rate on a tax-deferred basis. At any time you can borrow up to 90 percent of the cash value, or you can surrender the policy in exchange for the cash value. Upon your death the beneficiary receives the death benefit but not the cash value.

As the name implies, whole life provides coverage for your whole life. As long as you keep paying the premiums, your insurance coverage remains in place. There are two primary variants of whole life insurance:

Universal Life is a form of whole life where the policy holder gets to decide how much of the premium goes to the death benefit and how much goes to the cash value.

Variable Life is a form of whole life where the policy holder exchanges guaranteed returns for the possibility of higher gains in the stock market.

Beneficiaries

Typically the beneficiary of a life insurance policy is the policy holder’s spouse or partner. It’s important to note that minor children cannot be designated as beneficiaries. If a minor child is intended to be a beneficiary, a life insurance trust must be established.

Cost

The premiums for whole life are about 10 times higher than the cost of term life insurance. Let’s look at an example. 35 Year old Robert is in good health and married with two children. His wife doesn’t work outside the home. He needs life insurance to ensure his family will be taken care of in the event of his death. 

Robert can get $250,000 in term life insurance that will cover his family for the next 30 years. At the end of the 30 year term, he will be 65 years old and no longer need the insurance. The premiums are $21 per month.

Robert can get $250,000 in whole life insurance that will cover his family for the rest of his life. With a little more than half of the premiums going to the cash value and a guaranteed return of 5 percent, in 10 years the cash value will be $25,000. The premiums are $286 per month.

Conclusion

When faced with the cost of whole life insurance, most people opt for term life insurance. Some people justify it by vowing to invest the difference in premiums. The challenge is actually following through with it. In our example, the difference in monthly premiums between term life and whole life is $265. Properly invested, that would add up to a handsome sum over 30 years. It would also make a tidy little car payment.

Regardless of the type of coverage you choose, you need to get life insurance. Without life insurance, if something happens to you, your family may be headed for financial ruin. Every year you put it off you get another year older which translates into higher premiums.

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