Choosing the right life insurance

March 21, 2008

Protecting your family needn't be complicated or costly-if you know what to look for and what to avoid.

Key Points

Once in a while, you buy something you hope you won't need soon. Put life insurance right at the top of that list.

On its face, the concept of life insurance is simple. In reality, it's anything but. While there are two basic types-term and whole life (called cash value)-agents offer an array of options and combination products whose complexity can create many pitfalls for buyers.

The information that follows will help you cut through agents' sales pitches to find a life insurance policy that best meets your needs.

There's nothing complicated about a term-life policy. It insures you for a finite period of time-typically 10 to 30 years, but as little as one year-and has a fixed annual premium. When the term ends, you can either buy a new policy or dump it altogether. This plain vanilla form of life insurance is always cheaper than a comparable cash-value policy. For instance, a 40-year-old man who falls into an insurer's "super-preferred" nonsmoker class can expect to pay as little as $700 a year for a $1 million policy. That estimate is based on a 20-year, "level-term" policy. A cash-value policy with the same amount of coverage over the same span could cost $15,000 a year, but it has an investment component to it. Term insurance usually doesn't.

You can research term insurance and purchase it yourself, without going through an agent, although there's generally no great price advantage. To learn more. Although term policies generally lack an investment component, you can buy return-of-premium term insurance which entitles you to a refund of premiums when the policy expires, and, in some cases, to a partial refund after as few as five years. You'll pay a higher annual premium for this modification, and this "investment" is lost if you die or drop the policy before the partial-refund period ends.

The downside of term insurance? Although it locks in your rate for many years, it leaves you vulnerable about the premium price if you decide to take out another policy when this one expires. The jump in price can be quite high. For example, the premiums for the $1 million term policy mentioned earlier could rise from $700 a year to about $5,200 when the original 20-year term expires-and that assumes you're in good health. If you're in poor health, it could cost a whopping $28,500 a year.

The best way to solve that conundrum is to think hard-before you buy-about how long you'll need life insurance. If you have a 15-year fixed mortgage on your home, a single 20-year term policy might be plenty. By the time it ends, you'll likely have few (or no) major debts to pay off. Or if your children will have graduated from college by then, you may have less need for cash.

Cash-value policies: Part investment

Cash-value policies, unlike term insurance, come in several flavors, including whole life, universal life, and variable life. They differ from term life in three ways: The insurance can usually stay in force until you die, as long as the premiums are paid; the premiums can be scheduled to remain level for a specified period or to vary in amount; and the policies build up cash value that helps fund your continued coverage.

This cash value, in turn, earns compound interest-at least 4 percent currently, says Glenn Daily, a fee-based insurance consultant in New York City. If you purchase what's known as a "participating policy," it'll pay dividends, too. Traditionally, insurers generate the cash to pay policyholders by investing their premiums in a relatively conservative mix of stocks, bonds, mortgages, and real estate.

Cash-value policies have several other features that may appeal to you:

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