Welcome to Part 3 of a four-part series on life insurance that will explain its importance and guide you through the process of purchasing a policy that’s right for you and your family. You can follow along with the entire series here:
- Part 1: How to know when you need life insurance
- Part 2: How much life insurance do you need?
- Part 3: Choosing the right type of life insurance
- Part 4: A step-by-step guide through the process of actually buying life insurance
The first two posts in this series discussed whether or not you even need life insurance, and if you do how much coverage you need. At this point you’re almost ready to go out and purchase a policy, but there’s still one more decision to make: the type of life insurance you want to purchase.
The bad news here is that there are a number of different choices and there are many people who will try to sell you on the merits of each one. The good news is that for young parents, there is a single type of life insurance that will almost always be the best choice.
So let’s look at the pros and cons of some of the different options available, and narrow it down to the one choice that is likely right for you.
Individual vs. group life insurance
Many people have the option of paying for some amount of group life insurance through their employer. Group life insurance is a single policy that covers all employees (meeting certain employment criteria) no matter their health condition. Its two main advantages are that it’s often cheaper than individual insurance and it doesn’t require a medical exam, which is great for people with pre-existing conditions. For some people with poor health, it may be the only way to get coverage at a reasonable cost.
But there are two main disadvantages to group life insurance that need to be considered:
- There’s often a limit to the amount of coverage you can get. This may not be enough to cover your specific needs (see: How Much Life Insurance Do You Need?).
- It only provides coverage as long as your employer continues to offer the benefit AND you remain employed there. If either of those change, your coverage would likely end. In some cases you might be able to continue your coverage, but it would likely become more expensive. In any case, the point here is that you are not truly in control of the coverage.
Both of those issues are solved by an individual life insurance policy. This is simply a policy that you buy on your own, in the private market, completely separate from any employment. No matter what else is going on in your life, the policy will remain in force as long as you continue to pay the premiums.
In my opinion, an individual life insurance policy is the way to go for most young parents. You might use your work policy as a supplement, and there may be unique circumstances where your group coverage is truly all you need, or in some cases all you can get. But for most of us an individual policy will provide the best protection because no one can take it away from us.
Term life insurance vs. the rest
The most basic form of life insurance is called term life insurance. Term insurance is named as such because you buy a set amount of coverage that lasts for a set term, or number of years. Once that term is over, the coverage will end. So, as an example, if you buy a $500,000, 30-year term policy, you will have $500,000 worth of coverage for 30 years as long as you pay the premiums.
The other big category of life insurance is called permanent life insurance. This comes in all shapes and colors, but the two kinds you will hear about most are “whole” and “universal” (the distinction between the two isn’t incredibly important right now).
If you ever encounter a life insurance salesman, which almost all of us will at some point, they will likely push hard on the merits of permanent life insurance. The two main arguments they will use are the following:
- It lasts forever, as long as you pay your premiums.
- It has a savings component that you could eventually access for retirement, college, etc.
The will probably omit the fact that selling a permanent life insurance policy will pay them a much bigger commission than a term life insurance policy will.
I’ll be very clear with my opinion here. Permanent life insurance has its place, but it’s for maybe 2% of the population who has accumulated a lot of money and is trying to plan the passing of that money to future generations. Young people starting their families typically have no need for permanent life insurance.
For young parents, term insurance will be the way to go almost every time. There are several reasons for this:
Reason #2: There’s a very good chance that your only real need for life insurance will be while your children are dependent upon you. Once they are independent, your life insurance needs may completely go away. This would make the “permanent” part of permanent life insurance completely unnecessary.
Reason #3: Any good term life insurance policy will come with the option of converting some or all of it to permanent coverage any time before the term ends without requiring any proof of health. So if the need for permanent coverage ever arises, you have that option even with a term policy.
Reason #4: The savings component of a permanent policy sounds attractive, but there are much better ways to invest your money. See my post on Why Whole Life Insurance is a Bad Investment for more detail. You can also see here and here to start learning about the better investment options available.
How long a term do you need?
Once you’ve decided on term life insurance, the last question is how long that term should be. The answer to this depends largely on the age of your children, since their financial dependence upon you is likely the main reason you’re buying life insurance in the first place.
As a rule of thumb, you should consider getting a term that will last at least until your youngest child will be done with college, and therefore theoretically out on his or her own. For parents who are still planning on having children, that will generally mean a 30-year term.
That might sound like a long time, and the truth is that you may not end up needing coverage for that long. But there are three good reasons why I think erring on the conservative side and choosing a longer term for your life insurance policy is a good idea:
- While you don’t want to significantly over-insure, and therefore over-pay, it’s better to have a little more coverage than you need than to not have enough.
- You don’t have to keep the insurance for the full term. If you buy a 30-year policy but realize after 20 years that you no longer need coverage, you can simply stop paying the premiums and let the policy lapse.
- If at some point down the line you decide that you don’t need quite as much coverage, most policies will let you decrease the value of the policy and therefore decrease the premiums. In other words, you don’t need to worry about the amount of life insurance you need now being too much (and therefore too expensive) later because you can always reduce it.
For most young parents, an individual term policy with a 20-30 year term will probably be the right decision. It will provide the protection you need at a cost you can afford.
In the next and final post in this series on life insurance, we’ll talk about how to actually shop for and buy a life insurance policy.