Though it may be an unsettling thought, life insurance can provide a valuable financial safety net. Policyholders purchase life insurance while they are alive, and upon their death, the person they designate as their beneficiary receives the proceeds (also known as the death benefit). That’s a simple explanation of how life insurance works, but there are countless details and types. Understanding the details of these policies can help you decide whether life insurance is worth it.
Types of Life Insurance
The first step in finding the answer to whether life insurance is worth it may be to gain a basic understanding of the different types available. Knowing the differences can help you determine which insurance best suits your needs and financial goals. Life insurance is primarily divided into two categories: term life insurance and permanent life insurance. Each type has its own unique features, advantages, and disadvantages that cater to different needs.
Term Life Insurance
Term life insurance is designed to provide coverage for a specific period of time, usually between 10 and 30 years. If the policyholder dies during the policy term, the beneficiary receives the death benefit. Term life insurance is generally more affordable than permanent life insurance and is often chosen by individuals who need coverage for a specific period of time, such as until their children are grown or their mortgage is paid off.
The main features of term life insurance are:
- Affordable price: The low premiums make it affordable for many people.
- Simplicity: Easy to understand coverage without the complexities of cash value accumulation.
- Flexibility: We offer a variety of term lengths to suit different financial needs.
Term life insurance is considered a cost-effective way to provide financial protection at a time when you need it most, such as when providing for your family or paying off large debts.
Whole Life Insurance
Permanent life insurance is designed to provide coverage for your entire life, as long as you pay your premiums. Unlike term life insurance, it contains a cash value component, which accrues interest and grows over time, and can be borrowed or withdrawn. Permanent life insurance comes in several forms, including whole life insurance, universal life insurance, equity-indexed universal life insurance, and variable life insurance.
The main features of whole life insurance are:
- Lifetime coverage: It protects the policyholder for the rest of his or her life, with maximum coverage ranging from 95 to 121 years of age.
- Cash Value Accumulation: A portion of the premiums accumulates toward a cash value component, which grows tax deferred and is available throughout the policyholder’s lifetime.
- Investment options: Some permanent life insurance policies, such as variable life insurance, offer investment options for the cash value.
Permanent life insurance, which is typically much more expensive than term life insurance due to its longer coverage period and cash value component, can be a strategic financial tool for individuals seeking long-term estate planning, wealth creation, or a means to leave behind an estate.
Understanding these different types of life insurance policies can help you determine which option best suits your financial goals and needs, and ultimately whether a life insurance policy is worth it for your situation.
Is life insurance a good investment?
Life insurance is an insurance contract, not designed as an investment vehicle for the policyholder. Instead, insurance serves primarily as an income replacement. In financial terms, life insurance is an investment in the financial security of your loved ones, as the death benefit of the policy serves as an income replacement in the event of your death. In other words, insurance is often intended as a vehicle for your loved ones to cover living expenses in the event your primary source of income passes away. However, it is not usually viewed as an investment vehicle to make a profit.
Insurance types like permanent life insurance can also be part of a tax-deferred financial strategy that helps you avoid paying taxes on your savings until you’re in a lower tax bracket, perhaps in retirement. There are other ways to do this, like IRAs and 401(k) plans, but if your investments in those are maxed out, life insurance can play a small role in protecting your money.
Benefits of life insurance
Life insurance offers a variety of benefits that can provide peace of mind and financial stability to you and your loved ones and can be an important part of your financial plan. Life insurance can be customized to fit your specific needs and budget, so you can get the most value from your policy. Here are some key benefits that make life insurance worth considering:
Supplement your income
Life insurance can be used to replace the income that would have been provided to you. Any type of life insurance can provide this benefit, which is one of the main reasons to buy a policy. The death benefit helps ensure that other liabilities such as school fees, mortgage payments, and even basic expenses like bills and food are paid even after you pass away.
Leaving a Legacy
Whether it’s for your children or relatives, to continue the family business, or to donate to a favorite charity, you can use the death benefit of life insurance to leave a legacy. Life insurance payouts can often be very large depending on the policy, and who receives the payout is up to the policyholder.
Reduce stress for your loved ones
The death of a loved one and the responsibilities that come with it are stressful. When combined with the grief of the loss, the stress is often even more pronounced. Having life insurance, even if it’s just a small amount, can make this time easier. Money from life insurance can help pay for funeral expenses, flowers, grief counseling, and other services.
Can accumulate cash value
If you have a whole life policy, premiums are generally higher because it is designed to stay in effect for your entire life, rather than lapse after a certain number of years, and has a maximum coverage age of 95 to 121 years. With a policy that has a cash value element, a portion of the premiums you pay grows tax-deferred, earning interest and other benefits depending on the policy. You can access the cash value through withdrawals or policy loans, but this may affect the amount of the death benefit paid to your beneficiary. Withdrawals permanently reduce your beneficiary’s death benefit payment, whereas policy loans accrue interest but can be repaid while you are alive to replenish your beneficiary’s death benefit, if you choose. If you die before repaying the loan, your death benefit is reduced by the amount of the debt, so your beneficiary will receive less.
Whole life insurance offers a guaranteed interest rate and the cash value grows slowly. Universal life insurance is more flexible and can grow in interest faster, depending on the specific policy. Experts recommend consulting with a qualified insurance agent to determine what’s best for your situation.
Payments usually avoid probate
Life insurance is generally not considered part of the policyholder’s estate, avoids probate, and passes directly to the designated beneficiary. Creditors also typically cannot offset the policyholder’s liabilities against life insurance payments, because the proceeds belong to the designated beneficiary, not the policyholder’s estate. This benefit creates an estate transfer safeguard, so estate issues cannot prevent life insurance from financially protecting your loved ones.
Disadvantages of life insurance
While life insurance is beneficial for many people, it isn’t necessarily the best solution for everyone. Here are some of the drawbacks to purchasing life insurance:
Life insurance may be expensive for some people
The cost of life insurance varies widely depending on your age, health, lifestyle, the type of insurance, and the death benefit you choose. Younger, healthier people usually pay the least amount of life insurance. As you get older and have more health problems, life insurance generally costs more.
However, the higher cost of coverage may be most noticeable with permanent life insurance when compared to term life insurance, which is usually much cheaper. While life insurance is often less expensive than you might expect, price is certainly something to consider. You may need to speak with a qualified agent to determine if life insurance is worth it for you.
You may need to pass a medical examination
Many life insurance policies require a medical exam. The results of the medical exam are used to determine whether you qualify for insurance or how much the life insurance company will pay you. However, there are some cases where you can get life insurance without a medical exam.
If you face serious health risks, you can also opt for guaranteed life insurance. These options can be more expensive than the coverage you get with a medical exam, but they could be the best choice for some shoppers.
You may need to take the time to educate yourself.
When researching life insurance, you may encounter many new terms. For example, there are multiple policy types, benefits, and riders to understand, which can make it difficult to understand your coverage options. Because life insurance is a significant financial transaction, we recommend consulting with a financial professional to fully understand what you’re buying.
Term life insurance has an expiration date
Term life insurance is generally the least expensive, but if you do not die within the policy term, the policy lapses and no payment is made to your beneficiaries. Many companies offer renewal services, but the premiums at renewal are based on your current age and are therefore higher than the original fixed price. Many term insurance policies also include the option to convert the term policy to permanent life insurance before it lapses.
You can also consider purchasing a refundable premium rider, which means that if you don’t die during the policy term, your premiums will be refunded when the policy expires. Be aware, however, that these policies often get expensive on a monthly or annual basis.
Buy both term and permanent life insurance
Many people choose to buy both term and whole life insurance, each for different purposes. For example, some people buy term life insurance for the same term as their mortgage so that if they die before the mortgage is paid off, their spouse won’t struggle to cover the remaining payments. To supplement this, the same person may also buy a smaller amount of whole life insurance to keep as a form of permanent insurance. In this scenario, the term insurance covers the larger, more predictable potential expenses, and the whole life insurance covers the smaller expenses associated with death.
Options to consider beyond life insurance
Life insurance may not be the best option for everyone, and you should consult with a financial professional to determine the best path forward, but for certain aspects of life insurance, you may want to consider alternatives such as:
- Investing in the stock market: If you don’t mind taking on some risk, the stock market could be a good way to grow your wealth over time. This option is best for people who plan to hold their investments for a long period of time, usually 10 years or more. You’ll usually need to name a beneficiary for your account, but the amount your beneficiary receives when you die will depend on how well your investments perform.
- Specific Health Insurance Policies: Some life insurance policies offer survivor benefits, which allow you to use a portion of your death benefit if you suffer from a chronic, critical or terminal illness. You may also be able to access a portion of your death benefit if you need long-term care. You may be able to get similar benefits by purchasing certain health insurance policies that are not included in your life insurance. It’s worth comparing the features and prices of health insurance plans and life insurance plans with health-specific riders.
- Own funds: If you have the means, you can also set aside money in a separate savings account for when you pass away. This strategy offers similar benefits, as long as you’re diligent about saving and commit to not dip into other expenses. It can take a long time to save enough to cover end-of-life expenses, so start early.
- Getting the most out of your retirement accounts: Generally, the benefits of using traditional investment vehicles like a 401(k) or IRA outweigh the benefits of whole life insurance, and if you’re already maxed out on your annual contributions to such retirement accounts, you may be better off using whole life insurance as a supplemental store of value.
Is life insurance worth it to me?
To determine if life insurance is worth it for you, you need to evaluate your financial situation and personal circumstances. Life insurance is an affordable way to protect your loved ones from financial hardship in the event of your premature death, giving you peace of mind that they can maintain their standard of living and rest without the added stress of everyday expenses and debt.
However, if your primary goal is wealth accumulation and saving for retirement, traditional options like 401(k) plans and IRAs generally offer better growth potential and tax benefits.
For income replacement, term life insurance is usually preferred because of its affordability and the specific period of coverage it provides, such as until your mortgage is paid off or your children become financially independent. If you have long-term dependents, such as a disabled family member, permanent life insurance may be a better choice, providing lifelong coverage and the accumulation of cash value that can be accessed as needed.
To offer a more personal perspective on this question, we reached out to several Bankrate staffers who buy life insurance, and their insights highlight real-world scenarios in which life insurance has proven beneficial.
Sarah Gage, senior editor of credit cards at Bankrate, highlights a situation that illustrates the important role life insurance plays for single parents and homeowners.
“Because I’m a single parent and I also own my home, having life insurance is especially important to me. Currently, I have both traditional term insurance, which I purchased when I was self-employed, and employer-sponsored insurance. The amount is to allow my son to continue living at home (in a good but expensive school district with his friends) and begin life as an independent adult if necessary. Both policies have a small child benefit or child rider. I know the conventional wisdom is that term life insurance makes the most sense for people with dependents who rely on your income, but knowing that if something were to happen to my son, I would have peace of mind knowing that I could cover funeral expenses and take time off work without hesitation. It’s a depressing and painful thing to think about, but I worked in the funeral industry in the past and know that terrible things like that happen every day. But I don’t view life insurance as part of my retirement preparedness. Right now it covers my specific needs and I intend to reevaluate periodically as my situation changes.”
– Sarah Gage, Senior Editor of Credit Cards at Bankrate
Gage’s experience highlights the financial security that life insurance provides for herself and her son, giving her peace of mind.
Denny Ceizyk, senior mortgage writer at Bankrate, offers a different perspective, emphasizing the importance of life insurance in protecting your family’s well-being.
“Is the cost of your insurance worth the peace of mind? Absolutely. I bought a long-term policy when my daughter was born because I was the primary breadwinner and my wife was a stay-at-home mom. We met with a financial planner and it was one of the first things we discussed. I saw the difference in how families dealt with loss with and without life insurance. Families without insurance often fought over who was responsible for what. The sudden loss of income and the financial stress and anxiety over funeral expenses diminished their ability to heal from the loss of a loved one. I didn’t want my family to go through that.”
-Denny Sejczyk, Senior Loan Writer at Bankrate
Ceizyk’s insights highlight how life insurance can prevent financial stress during difficult times and ensure loved ones are taken care of.
Life insurance is a versatile tool that can provide financial security and peace of mind. Evaluating your specific needs and financial goals can help you determine whether life insurance is worth it, and speaking with a financial professional can provide personalized advice to help you make the best decision for your situation.
