Life Insurance Basics: Part One

by Joe Plemon on September 10, 2009

Snoopy is in Love
Creative Commons License photo credit: tinou bao

If your response, when asked what kind of life insurance you have, is “The kind Snoopy likes”, then you need to read this article. While not intended as an all inclusive explanation of life insurance, it will serve as a primer to help you better understand what you have and what you need. We will follow a question-answer format.

What are the different kinds of life insurance?

Life insurance is categorized as “Permanent” and “Temporary”.

Permanent insurance remains in effect until needed unless the owner defaults by failing to pay the premiums when due. Permanent life insurance (Whole, Universal or Variable) builds cash value.

Temporary insurance is always called “Term” because it is purchased for a specific time period. Term insurance is also referred to “pure” insurance because the owner pays for insurance only, with no cash value accumulation.

What is the purpose of life insurance?

Life insurance is for one purpose: to replace lost income due to death.

Does everyone need life insurance?

No. If the lost income would have little or no negative effects on the live of the survivors, then there is no need for life insurance. Some examples would be:

  • A dependent child. There is no lost income and therefore no need for life insurance. However, the parents may need to place a rider on their policies to cover burial.
  • A single adult with no children. No one else depends on the income, thus no need for life insurance. However, a small burial policy may be needed.
  • Anyone who is self insured. What do I mean by self-insured? Those who have done so well managing their finances that their survivors will do fine without needing a life insurance payout. These people would have paid for houses, no debt and a healthy retirement and investment portfolio. This, by the way, should be everyone’s goal.

How much insurance is enough?

Deciding how much life insurance you need to buy is a common dilemma. Enough to replace the income which would be lost due to death. How is this done? One needs a nest egg large enough, when invested, to be able to generate this lost income. If, for example, one could earn a 10% return, he would need a policy which pays 10 times the lost income. I realize 10% is optimistic, so I consider this factor of 10 a minimum amount of life insurance you need.

Stay tuned for Part Two

In our next post we will discuss:

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