Understanding life insurance

Life insurance isn’t a fun thing to think about, and it may seem like an unnecessary expense.

But if you have people who depend on you for financial support, then life insurance is really about protecting them in case something happens to you – your designated beneficiary would collect a financial benefit upon your death.

Life insurance can be confusing, so here’s a rundown of the basics.

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Types of life insurance

Life insurance is divided into two categories: term and permanent (also sometimes referred to as whole).

Term life insurance

Term life insurance has a specified coverage period (term), but can usually be renewed or converted into a permanent policy at the end of the term. Premiums are generally affordable initially, but can increase substantially when renewed.

Whole life insurance

Whole life insurance is a type of permanent insurance that offers life-long coverage combined with a guaranteed cash-value savings component. This type of policy has higher premiums than term life. Premiums remain constant throughout the policy and a portion is invested by the company, which becomes the cash value of the policy. Whole life insurance pays a fixed amount upon death.

Universal life insurance

Universal life insurance is another type of permanent insurance policy that combines term insurance with the ability to earn interest on the cash value, paying a market rate of return. Cash value grows tax-deferred, and can be withdrawn or borrowed from the policy. It is more flexible than whole life insurance as it also allows you to change your premium payments and death benefit, within limits.

Variable life insurance

Variable life insurance is similar to universal life insurance in terms of flexibility and an investment aspect. However, instead of simply earning interest on the accumulated cash value, policy owners have more control over how to invest that cash. The ability to invest in professionally managed investment options allows for the potential to accumulate cash value while providing death benefits protection. However, there is greater risk for loss due to this benefit.

How much life insurance do I need?

It’s hard to know how much to buy. Many people decide based on an income replacement calculation, between 5 and 10 times the amount of your current income.

Think about your personal circumstances: Is yours the sole income in your household? Are there other expenses, such as college tuition, that may arise in the future? Don’t forget to include potential medical and funeral costs. Above everything, you want to be sure your family does not get stuck with bills, debts or expenses that they cannot afford. Depending on your needs, you may want to consider buying supplementary coverage beyond what your employer offers.