Life insurance can seem like a complex topic — the product descriptions alone can sound like a foreign language. But the basics of life insurance aren’t difficult to understand.
The primary purpose of all life insurance is to provide a benefit to people you choose (called “beneficiaries”) upon your death. Typically, these are people who depend upon your income to meet their daily needs.
There are two types of life insurance: term and permanent. Term insurance covers you only for a specified time period — 10, 20 or 30 years, for example.
Permanent insurance is as it sounds — coverage that remains in place until you die. In addition, permanent life insurance can be a financial tool that can help you build wealth and a cash reserve to use during your lifetime.
Let’s look at them more closely.
What is term life insurance?
Term life insurance is a simple, relatively inexpensive way to get life insurance coverage. If you die while your coverage is in force, your beneficiaries get the payout. If you don't, the policy stays in force until the end of the term.
For simplicity’s sake, think of term life insurance like renting an apartment. There are a lot of similarities:
- You plan to use it only for a limited period of time
- It’s often less expensive than purchasing
- You don't build equity
- At the end of the lease term, it’s gone
It may seem odd that anyone would purchase life insurance that ends after 10, 20 or 30 years, but there are circumstances in which it makes sense. For example:
- If you’re young, you may want simple, inexpensive coverage just to pay off debts, leave money to your significant other, or absorb funeral costs.
- If you’re fiscally minded, you may want to lock in a 20- or 30-year premium at a relatively low rate while you’re still young and healthy.
- If you’re in the final decade of your career, you may want coverage in an amount that would replace lost income if you pass away, enabling your spouse to still achieve retirement goals.
What is permanent life insurance?
Permanent life insurance provides protection for your entire life — it doesn’t expire like term life insurance.
If term life is an apartment you rent, permanent life insurance is the home you purchase and plan to keep for the rest of your life. Here are some similarities:
- You own it for life, as long as you pay your premium
- You typically pay more for it
- It has equity (called cash value) that grows over time
- It’s an asset you can borrow against
- It will benefit your loved ones in the future
Permanent life insurance is generally more expensive than term insurance, but you can put it to use as a financial tool during your lifetime.
For example, it holds a cash value that you can withdraw, borrow against or list as an asset when you are applying for credit. Many people use the cash value at crucial times — to help pay for college or as supplemental income during retirement, for example.
Permanent life insurance comes in a variety of types and options. When you start to hear terms like fixed, flexible, whole, universal — they all fall under the permanent life insurance category.
In addition to choosing the type of insurance you need, determining the amount you need is very important. It is a good idea to meet with a financial professional to determine the coverage that best fits your needs — now and in the future.