Tuesday, October 19, 2010

Life Insurance Primer. Part One: Introduction

Life insurance is something that many people need, but not everybody truly understands.  It seems deceptively simple on the surface:  you pay small amounts of money to an insurance company in return for the promise to pay your heirs a bigger amount of money when you die.  However, there are so many options and variations that it can quickly become confusion to even the most financially savvy person.  Because of its surprising complexity, I have decided to dedicate a series of posts to explaining the different forms of life insurance.  This may be an impossible task at which even the mighty MBTN might not be able to succeed.  In case I should fail, I want to start with the number one rule of life insurance.  If you don't understand anything else, please remember this:

Most people should buy term life insurance and forget the rest.

With that out of the way, let me introduce to you the various forms of life insurance.

1. Term Insurance:

Term insurance is, by far, the simplest form of life insurance.  You pay a premium to a life insurance company and, in return, they pay your heirs the policy amount when you die.  As long as you pay your premiums, your heirs will get the money.  If you stop paying, your heirs get nothing.  No fuss, no muss.

2. Whole Life Insurance:

Here is where things start to get complicated.  With whole life insurance, some of your premium goes into an account known as cash value.  The cash value earns interest like a savings account.  If you die, your heirs get the policy amount.  However, if you decide to stop paying your premiums, the insurance company gives you back any money that has accumulated in the policy's cash value.

3. Universal Life Insurance:

This adds another twist to whole life insurance.  With universal life, you can choose to deposit additional money into the policy's cash value above and beyond your normal premiums.  Thus, if you have extra money you want to save, you can choose to "invest" it with the insurance company.

4. Variable Universal Life Insurance:

Not to be outdone, insurance companies have added yet another variation into the mix.  With variable universal life, you can choose how your cash value is invested.  Rather than just earning interest at a rate set by the insurance company, you can decide to invest your money in stocks, bonds, or other investment options.  In essence, your insurance policy becomes like a brokerage account! 

As you can start to see, life insurance can be quite complicated with all of these different options and variations.  In my next installment, I will go into more details about term life insurance, how it works, and what some of the common options are for it.  Stay tuned!

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