How to Choose the Right Type of Life Insurance

How To Choose the Right Type of Life Insurance

Photo courtesy of peddhapati

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:

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:

  1. 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?).
  2. 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:

  1. It lasts forever, as long as you pay your premiums.
  2. 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 #1: Term insurance is MUCH cheaper than permanent insurance. This allows you to fully cover your family’s life insurance needs without sacrificing other important financial goals.

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:

  1. 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.
  2. 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.
  3. 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.

Conclusions

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.

GET THE ROAD MAP
Start building a better financial future with the resource I wish I had when I was starting my family. It’s free!
30 Comments... Read them below or add one of your own
  • Holly Johnson January 20, 2014

    We have 30 year return-of-premium insurance. Basically, we pay in a little over $18,000 over thirty years then get it back when our term insurance expires. We bought it in our mid-20’s and I’m glad we did but I’m not sure we would buy the same kind again. When we bought additional life insurance last year, we just bought regular term.

    • Matt @ momanddadmoney January 20, 2014

      I like that you guys took the time to revisit your needs and get some more. Life insurance is one of those things that can be easy to set and forget, but that’s a great reminder that needs change.

      • Andrew January 21, 2014

        what is your opinion on return of premium type insurance policies? It sounds good because you’ll get your money back. But, I’m thinking the premiums are higher since they’d have to return the premiums to you when it expires? Maybe better off saving on the premiums and investing the rest.

        • Matt @ momanddadmoney January 21, 2014

          I would find a regular term policy with the same face value and term. Term4sale.com is a good place for quotes. Then I would take the difference in premium between the two policies and do a quick calculation in excel as if you’re investing that amount each year and at the end of the term your balance is the return of premium. It may or may not be a decent rate of return.

  • Michael Solari January 20, 2014

    I’m in total agreement with term policies. People are often misled about the savings side of whole life policies. It’s not that easy to get the money out and if you do it defeats the purpose of what whole life is built for (using the dividends to purchase more insurance).

  • Brian @ Luke1428 January 20, 2014

    “The savings component of a permanent policy sounds attractive, but there are much better ways to invest your money.” Absolutely right Matt! If you buy term insurance, then save and invest properly for 30+ years, you will have enough towards the end of your life. No need for whole life. Good post!

  • Shannon January 20, 2014

    I love that you are talking about insurance Matt. As you know, I just lost a friend who was 40 with two young children and even though we want to believe we will live until retirement, it is not a given. Insurance is such a great piece of mind! I think many people feel they are “covered” if they have coverage with their employer; however, I had a friend recently who left a company and could not get individual coverage because he had developed a “condition” that was uninsurable. Even if you have coverage with your company, it makes sense to get “extra” on your own.

    • Matt @ momanddadmoney January 20, 2014

      I’ve never had employer coverage, but even if I did I think I’d basically treat it like it wasn’t there. Whenever possible I want my insurance to be mine and not have it tied in any way to the whims of an employer.

  • MyMoneyDesign January 20, 2014

    I’m all about the 30Y term. Affordable, practical, and it does what I need it to do – protect my family for the next 30 years! Forget about life insurance as an investment – there are lots of better investments out there that you can make!

  • DC @ Young Adult Money January 20, 2014

    “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.” I plan on getting this very soon. I don’t have kids yet, but I do have a wife, student loans, and a mortgage and I think we both need to get financial protection for a worst-case scenario.

    • Matt @ momanddadmoney January 20, 2014

      I’m looking forward to hearing about your experiences with it. If you’re planning on having kids soon, it can make some sense to get it now just to make sure you can lock in the rate.

  • Done by Forty January 20, 2014

    I’m a big proponent of term but I have a hard time telling people why whole life is generally a bad idea. I say that there are better ways to invest and that there are not great ways to actually get the money out of your investments, but can’t really give advice beyond that. Now, I can just point people to your blog. 🙂

  • jefferson @seedebtrun January 21, 2014

    I admit.. When I bought my first life insurance policy, it was a whole-life policy. But that was just because I was uneducated. As soon as I found out that the payout on a term policy was over 10x what my whole-life policy was playing, I switched that very day.

    • Matt @ momanddadmoney January 21, 2014

      Glad you were able to make the switch so easily. Live and learn. That’s what it’s all about.

  • Laurie @thefrugalfarmer January 21, 2014

    We each have a term policy, but we also each have a whole-life policy that we got dirt, dirt cheap when we were super young. It’s a great policy with a well-known company. I would never advise one to purchase a whole-life policy nowadays, but we got lucky with a large policy for a pittance of a monthly premium.

    • Matt @ momanddadmoney January 21, 2014

      Glad to hear you’ve got policies that work for you Laurie. Just goes to shows that there are always exceptions to the rule and in the end it’s all about what’s right for you personally.

  • BrokeMillennial January 21, 2014

    Matt, I love how practical so many of your posts are. I always learn something great when I visit your site. I’m without life insurance right now because I’m debt-free with no dependents. As soon as I plan to get married/have babies, I’d certainly get a policy. My boyfriend does have one though, I guess his rationale was because he has debt. I’m not sure of the type though, I’ll have to ask!

    • Matt @ momanddadmoney January 21, 2014

      Honestly Erin, no joke that’s probably the highest compliment I think you can give me. Thanks! If you end up having any questions about your boyfriend’s policy please don’t hesitate to reach out.

  • AvgJoeMoney January 21, 2014

    Another great post in the series. I especially love the part about the transient nature of workplace policies. People always forget the fact that your insurance goes bye bye if you leave the job. If you’re uninsurable at that time, that might be ugly.

    • Matt @ momanddadmoney January 21, 2014

      Thanks Joe. That’s such a key point in my opinion. I just can’t imagine relying on an employer plan as anything more than a nice little supplement to my own policy.

  • Lisa womack December 30, 2014

    I notice your site visitors were young adults, how insurance should a couple age 52 apply for?
    Would you suggest 10, 15, 20 year policy?

    • Matt Becker January 2, 2015

      Hi Lisa. The big question here, no matter where you are in life, is what you’re getting life insurance to protect. If it’s your children’s financial security, then it’s primarily a question of how much longer you expect them to be financially dependent on you. If it’s to provide your spouse with the funds to pay off joint debt, then it’s a question of how much longer you expect that debt to last. In other words, how much life insurance you need, and how long you need it for, is really dependent on the reason you’re buying it rather than the age at which you’re buying it.

      I hope that’s helpful, but please feel free to reach out if you would like some more specific input for your situation. I’m happy to help!

  • Kim October 17, 2015

    Very glad I stumbled across this. I feel like I was very uneducated in life insurance when I bought my policy. . I had a feeling I was “sold” into whole life policies for my husband and I. Paying the premium has been straining our bank account. I believe a change will be coming soon!

    • Matt Becker October 18, 2015

      I’m glad it helped Kim! Feel free to reach out directly if you’d ever like some help with this. And in any case I wish you the best of luck!

  • Vhanessa March 14, 2016

    Excellent read! I never really gave life insurance much thought. I imagine it is not too late for my family of three, including my now 4-yr old son.

    • Matt Becker March 14, 2016

      It’s definitely not too late Vhanessa! I hope the rest of the series helps you figure out the rest of the process as well. And please reach out any time if there’s any way I can help. Good luck!

I’d love to hear from you, please leave a comment