An Effort To Simplify Life Insurance Needs

Understanding life insurance policies

Insurance is often a very important component of a sound financial portfolio. However, the needs of each person is unique, especially when it comes to life insurance.

When deciding on life insurance policies, there are several important things to consider.

​First, you need to consider your current debt to income ratio. If you are the high earner in the household, and carry a lot of debt, taking out a larger policy on yourself is probably justified. Even if you are a low earner, but carry a large amount of debt, considering a medium to large policy is definitely warranted. 

It is also important to consider where you estimate you will be in the future regarding your financial situation. If you are a habitual saver, perhaps taking out a larger policy now and shifting to a smaller, more affordable policy later would be justified.

If you are already financially independent, saved 5 or more years worth of expenses, and carry no significant debt, life insurance may not be needed at all. It is definitely a conversation worth having with your financial professional.

What is Life Insurance?

Basically, it is a contract. The payer (insured) is in contract with the insurance company. The exchange is a monthly premium for a "potential" lump-sum payout. To remain under contract, the insured pays a monthly premium to remain eligible for a "death benefit", which is often the lump-sum payout.

If you ever wanted to discontinue your policy, you could just simply stop paying the premiums and your coverage would cease. I would check with your provider first however. 

Common Types of Life Insurance

Basically, there are two types of life insurance. There are fixed term policies and there are lifetime policies.

Fixed term policies are often referred to as term policies, or term life insurance. This type of policy provides coverage for a fixed period of time, most often 25-30 years. Term insurance is the most popular type of insurance chosen by followers of the financial independence and financial freedom movements as it is typically the more cost effective form of life insurance.

Lifetime policies typically come in the form of whole and universal life insurance. These policies typically carry a much higher premium, however they are payable for the lifetime of the insured instead of expiring after a pre-determined period like a term insurance policy.

Essentially, for a higher monthly premium you stay eligible for a "death benefit" payout under a lifetime policy. In a term policy, if you are not deceased prior to the policy expiration date, there is no "death benefit".

Why I Chose Term Life Insurance

My thought process, like many F.I. followers, is that I chose the policy with the greatest amount of value.

Term insurance affords a much lower monthly premium than a lifetime policy. This allows me to instead invest the difference in cost between the two policies, month after month, compounded over time. 

By investing the amount I am saving with a term policy, compared to a lifetime policy, I will take advantage of the effects of compound interest. While taking advantage of this investing strategy, I do not leave myself "exposed" to significant losses of income that my family would incur should I meet an untimely demise. This is because I still have a substantial "death benefit" payout with my term life insurance policy. 

I chose to avoid a lifetime (universal or whole life insurance) policy because I anticipate reaching a significant amount of net worth and savings by the time my term life insurance expires.

In other words, if you anticipate saving and investing for the next 30 years, you will likely have a significant amount of money at the end of that term. The need for continued coverage beyond this point, like you would receive with a whole or universal life insurance policy, is unnecessary and very expensive. 

Overall, everybody is different

Assess your needs on an individual basis. Consult with a financial professional.

Not everyone will benefit from a term policy over a lifetime policy. Your circumstance may be unique. Consider your overall picture (time horizon, investing strategies, savings rate, anticipated expenses, etc.) when determining what type of life insurance policy will best meet your needs.

In the end, whichever policy you choose, I do feel that life insurance in general is an excellent thing to consider for anyone with a spouse or dependents that will be deeply impacted by your loss of earnings upon the event of your death.