It’s really pretty simple…
Earlier I said there were two categories of insurance. One is for stuff and the other is for people. We did the stuff thing; now it’s all about you!
There are lots of different kinds of insurance for people.
Insurance for people, as you could guess, is insurance on a person. Let’s go through the main types: Health, life, and disability.
Health – Not much to explain here. You already understand this one. You pay premiums, and if you get sick or hurt, the insurance company helps pay the medical bills.
Life – Now, with this one, there is more to explain. It’s not quite as understood. Basically, if you die, then the insurance company pays whoever you want some money. Sounds kind of sick, doesn’t it? But there are some really important uses for life insurance.
Let’s pull back the onion layers a bit here and get down to the basics.
- The cost of the insurance, the amount you pay, is called the premium.
- The benefit, also called the death benefit, is the money the insurance company pays when you die.
- The insured is the person who is insured. If they die, then the insurance company has to pay.
- The beneficiary is the person who gets the money; it is the per- son the insurance company pays if the insured dies.
There are probably hundreds of types of life insurance, but the good news is you really need to only know the two big categories. There is term life insurance and then there is permanent life insurance. That’s it! Just those two.
So what is term life insurance?
It’s basically a policy that you buy for a certain number of years, and at the end of the term, you no longer have the life insurance. Some people call it renting a life insurance policy. Imagine renting an apartment. You don’t really own it, but if you pay your rent each month, your lease is good for one year. At the end of the year, the landlord can kick you out. The most common lengths of term insurance are 10 years, 20 years, and 30 years. What this means is that if I have a 20 year term insurance policy, as long as I pay the fee, the premium, to the insurance company each year, I am guaranteed to have this policy for the next 20 years. If I die over the next 20 years, then the insurance company has to pay my beneficiary. But what if I die 20 years and one day later? Who does the insurance company pay? Sadly, no one because your 20 year term policy expired. It vanished. It went away at the end of the 20 years. It’s like a carton of milk with an expiration date. Once that date comes, the milk is bad and you can’t use it anymore.
So why would anyone want a disappearing life insurance policy?
It’s cheap. You can get quite a big death benefit for very little premium. And this can make sense for a lot of people. Let’s say it’s a young family and they don’t have a lot of money to spend on insurance. They can get a cheap term life insurance policy and if the dad dies, then the insurance company can pay the mom.
Okay, so that’s term insurance. Cheap and it has an expiration date.
So if you had to guess what permanent life insurance is, what might you say?
The keyword here is permanent. Unlike term insurance that has a limited term, permanent insurance is forever. As long as you pay the premiums, this insurance has no expiration date.
Pop Quiz: If you had a permanent insurance policy, which of the following will the insurance company pay if you die?
- 10 years
- 20 years + 1 day
- 32 years
- 87 years + 6 days
All of the above!
It sounds like permanent life insurance is the way to go because it never goes away, but, of course, what do you think the downside is?
It’s more expensive.
Quite a bit more expensive, actually. But, it can definitely make sense in the right circumstances.
Okay. Got it? Life insurance comes in two flavors. One that melts and goes away (term), and the other that stays forever (permanent). Term is less expensive, and permanent is more expensive.
Is there job insurance? Stay tuned.
The proceeding blog post is an excerpt from Get Money Smart: Simple Lessons to Kickstart Your Financial Confidence & Grow Your Wealth, available now on Amazon.
About the Independent Financial Advisor
Robert Pagliarini, PhD, CFP®, EA has helped clients across the United States manage, grow, and preserve their wealth for the past 25 years. His goal is to provide comprehensive financial, investment, and tax advice in a way that was honest and ethical. In addition, he is a CFP® Board Ambassador, one of only 50 in the country, and a real fiduciary. In his spare time, he writes personal finance books, finance articles for Forbes and develops email and video financial courses to help educate others. With decades of experience as a financial advisor, the media often calls on him for his expertise. Contact Robert today to learn more about his financial planning services.