Life Insurance: The Basics
How it works: Term life insurance works like a homeowners' policy. You pay a fixed premium for a certain number of years (say, 20 or 30), and if you die during that time, the insurance company pays the claim. With a "whole life" policy, you pay a higher annual premium, but you accumulate cash that you can borrow against or withdraw from your policy if you need it.
Why? The reason to buy life insurance is to protect your family. There are few things worse than dying and leaving those who depend on you without a financial safety net.
A whole life insurance plan also can offer additional income during retirement. These plans offer guaranteed cash value accumulation that grows each year on a tax-deferred basis. This cash accumulation is sometimes referred to as a "living benefit," and you can access that growth to provide supplemental tax-free retirement income. In addition, borrowing against a life insurance plan offers tax benefits that aren't available from other retirement strategies, such as liquidating a stock portfolio, because life insurance cash values can be accessed without generating any income tax liability.
Why not? Because whole life insurance covers the entire life of the policyholder, the premium rates can be high. If you're using life insurance as an investment tool, the cash value received can be lower than the alternatives available in the market. With many life insurance products, the insurer manages the whole process, so you can't improve the returns of the policy by investing in different stocks or bonds. In the case of variable life insurance, in which you control the investment, you, rather than the insurance company, also incur the risk of loss.
The fine print: Every insurance policy is different, with its own conditions, exclusions and guarantees. Be sure to review all documents before signing to look for items such as the premium payment grace period information, level premium payment terms, guaranteed renewability, exclusions from proceeds payment (such as sky diving, auto racing, or extreme sports competition), and ability to reinstate coverage after a policy lapse.
How much life insurance do you need? Use this calculator.
Shopping for insurance: Rate comparisons for the top 15 life insurance companies.