Life insurance is no different than any other insurance. This type of insurance is specifically designed to deal with the financial consequence of your early death. It would protect your remaining family since you are not around to continue to earn your living. It would pay off a mortgage, put children through college or create a financial safety net for a spouse or children.
How do you decide how much coverage you should have?
The easiest way would be to use a multiple of 8 to 10 times your salary. If you make $10,000 a year, you would buy $100,000 of coverage. The pay out of $100,000 could be invested and the interest income from the money would be equal to your prior income of $10,000.
This formula would get adjusted depending on where you are in your life. If your children are gone and your mortgage is paid off, you would obviously need much less coverage. You need to adjust this basic formula depending on your own financial situation.
What types of insurance are there?
There are 2 basic forms of coverage — term and permanent.
Term gets its’ name from the fact that it is designed to cover your “exposure” for a term or period of time. This coverage comes in 1,5,10, 20, and 30 years terms. This is how frequently the premium gets adjusted. (A 30 year term policy would have the same premium for all 30 years. A one year term policy would have a new, higher premium every year.)
The advantages of term coverage would include its’ low price and ability to design the coverage around a specific need (for example: 30 year policy for a 30 year mortgage). The disadvantage is that if you do not pay the premium, the coverage terminates.
The other form is permanent coverage. This is also known as whole life or universal life.
This coverage gets its’ name from the fact that it is designed to be in force whenever you die. Unlike the term policies, it does not end. The premium is higher than term coverage because a portion of the premium accumulates in a cash value portion of the policy.
The premiums for permanent coverage tend to be three to four times higher than the term premiums for the same amount of coverage.
This type of policy is generally used to supplement term policies to take care of final expenses. It can also be used to fund a trust for inheritance or tax purposes.