Understanding Life Insurance: Part One

Life insurance is a plan where you pay money to an insurance company while you are living, and the insurance company pays your chosen beneficiary upon your death.  The longer you live, the more profit the insurance company makes.  Life insurance is a must for anyone with family responsibilities and little personal wealth.

Understanding Life Insurance

Typically this type of insurance is misunderstood by the general public.  The industry has a perception of over-selling gimmicky products that play on your emotions, leave you underprotected, and offer little in the way of real value.

Here are a few terms that you need to learn when understanding life insurance:

  • Beneficiary – The person who receives the death benefit or face value of the policy
  • Death Benefit – The dollar amount that will be paid to the beneficiary if the insured dies
  • Group Insurance - A plan which a number of employees or associates and their dependents are insured under a single policy, usually with lower premiums than an individual policy
  • Policy Term – The period of time in which the insurance is in force.  The term can range from one year to an entire lifetime
  • Premium – The dollar amount you pay to the insurance company.  Premiums can be paid annually, or in monthly installments
  • Rate – The cost of a unit of insurance.  For example a rate of $30 per $1,000 unit means that $300 would buy you $10,000 of life insurance
  • Universal Life – Term insurance bundled with an investment plan.  The premiums are variable, with the amount in excess of the insurance premiums going into the investment plan

Life insurance is a trillion dollar industry and with all of the marketing and sales out there targeting your money and playing on your emotions, it is important to arm yourself with some knowledge about the terminology as well as the products that are available to you so that you can choose what option (if any) is best suited for your needs.

Here are a few tips to help you determine how much life insurance you may require:

  1. If you are single with no dependents, don’t buy life insurance – Life insurance should only be purchased to prevent a financial hardship that would occur if the insured died.  If you are single, invest your money for retirement.  Who are you going to leave the insurance proceeds to, your dog?
  2. Never buy life insurance on children – Here’s where the emotional games come into play.  Although your children are an emotional asset, they certainly are not a financial asset.  Unless your child is the next Miley Cyrus, your money should be placed in an RESP or savings account for them.
  3. Insure the income earning spouse – If your spouse is the sole bread-winner in the family, they are a financial asset and purchasing term insurance for them makes sense.  If you have no children and your spouse stays at home or works part-time, even cheap term life insurance is unnecessary.
  4. For two-income families, live on one salary instead of buying life insurance – For the double-income-no-kids couples out there, you need very little life insurance, if any.  A good career represents far more substantial financial security than a life insurance policy.
  5. Buy life insurance on a spouse at home if you have dependent children – Your stay-at-home spouse can be a full time caregiver, chauffeur, teacher, and cook.  While more difficult to quantify, this still has tremendous monetary value.  Inexpensive term life insurance will provide the financial protection you would need if your family were to become a one-parent household.
  6. As you get older, replace life insurance with other income sources – Your need for life insurance will decrease over time as your dependents grow older and your net worth increases.  And the greater your passive income streams are, the less life insurance you will need.  Income from dividend paying stocks are a perfect example of how to transition from buying life insurance to becoming self-insured.

Next week we will look at insurance products and some do’s and don’ts when purchasing your life insurance policy.


6 Responses to Understanding Life Insurance: Part One

  1. Dr Dale Rathgeber says:

    Great post. This good work demonstrates the power of the web and blogging, with regard to financial and insurance issues. Your readers are getting good and free advice. Keep up the good work!

  2. Thanks for breaking this down for the rest of us. We need more of this! Thanks and 5+.

  3. Life insurance is a must for anyone with family responsibilities and little personal wealth

  4. I agree. Life insurance is a must for anyone with family responsibilities. For two-income families (#4), although a good career is a must for true financial security, life insurance offers an important safety net to help transition past a tragedy. In many cases, it is still a wise financial move, no matter how small the death benefit.

  5. Kat says:

    Life insurance will be necessary to pay for funeral expenses if you don’t have any money socked away if you’re single with no dependents. Keep that in mind!

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