There's an old saying in the life insurance business, "Buy term, and invest the rest." The thought behind the phrase is pretty simple. Insurance is for mitigating risk. Investing is for creating a return on invested capital. Don't mix the two unnecessarily. If you need to buy insurance, you should buy the least expensive kind and only buy it for the amount of time that you've determined you need it. That analysis will lead you to term insurance, at least initially. Then if you have money left over you should invest it in a manner that minimizes your expenses and is consistent with your tolerance for risk.
But how do you know if you need insurance? Well, if you were going to be tested on that question for the purpose of obtaining an insurance license, you'd be expected to be able to identify the eight reasons below:
1 - To protect your family in case you die prematurely. This is the most basic reason for purchasing life insurance. People die unexpectedly all the time. If that person happens to be the primary breadwinner in a family, that death might create undue financial hardships in terms of liabilities that persist after death like mortgages, car payments, etc,. And even if that person isn't the primary breadwinner, the untimely death might create financial issues where none existed previously like childcare, homemaking, and even the loss of any secondary income. Income replacement properly summarizes reason number one for purchasing insurance.
2 - To create an estate. You might determine that you will not be able to leave behind the type of estate that you would like to. You can use life insurance to "create" an estate to pass on, provided you can pay the premiums. The earlier you make this decision the better as age and health sell life insurance.
3 - To protect an estate. When you die, your heirs will have to pay taxes on what you pass to them. If you would like to keep the government from taking too much of what you had planned to leave your loved ones, you can buy insurance for the purpose of paying the estate taxes, thereby relieving your heirs of that burden.
4 - To guarantee insurability. Many young parents (and grandparents) who are worried about potential health issues purchase insurance on their young children to establish insurability while they're young and inherently more insurable. The idea is that as they get older they can always increase the coverage amounts of existing policies without providing evidence of insurability through health exams. That means that if they develop health conditions later in life, they're already covered.
5- To create a cash value savings account. With anything other than a term policy, there is the opportunity to build up a cash value by routinely paying the premiums. This is a kind of forced saving account and, in my opinion is the worst reason for buying insurance.
6 - To protect a s business if a key person dies. Business owners will often purchase key person insurance policies to protect themselves against the untimely demise of a key employee. The specific knowledge, skills, and abilities of the deceased individual are typically not easily replaced, but the proceeds from key person policy can help buy the business time to rebuild the lost knowledge by providing capital for additional resources and training.
7- To protect remaining partners in a business if one partner dies. There are cases where one partner dies and it would be impractical, for any number of reasons, for the surviving partner to continue in the business with any of the deceased partner's heirs. Policies known in the business as buy-sell agreements allow for this by making funds available upon a partners death to "buy out" the heir's interest in the business.
8 - As a part of employee's compensation package. There are times when a business buys life insurance on an employee, who is usually an executive, as a fringe benefit to that employee.
So there you have a brief discussion of the reasons for buying life insurance. Along with why to buy, who buys and when were also mixed in the discussion above. In future posts, we'll get into what types of policies are out there to be bought. Stay tuned.