The Basics of Life Insurance

The Basics of Life Insurance

by Byron Udell, December 2009

As your life changes, so does your need for life insurance. When you are young and single, you most likely do not need much. However, as you take on more responsibility, the need for life insurance increases.

The fundamental purpose of life insurance is to provide your dependents with the financial support they would lose if you died. For most people, term life insurance makes the most sense. Term gives you the most protection for your money. Period.

Term life insurance is by definition temporary insurance. Each year, you pay a premium to cover the risk of your death during that year. Term life insurance has no cash value. The only way to collect anything is to die before the term life insurance expires. If death occurs, your beneficiary will (other than in rare exceptions) collect the death benefit free of income tax.

If you're shopping for term insurance most experts recommend, as a "rule of thumb", buying a policy with a death benefit equal to 10 times your salary. However, life insurance isn't a one-size-fits-all product. Everyone's needs are different. You should consider your annual income before tax, how much your dependents need, and their current age to get a better estimate of your family's needs. To help decide how much coverage to buy, you may also use the free life insurance needs calculator at

If you're looking for a savings strategy or if your estate is large enough to be subject to the estate tax when you die, then you should consider a permanent life insurance policy.

A permanent life insurance policy is a policy that will provide life insurance coverage throughout your lifetime - the policy never ends as long as you pay the premiums. In addition, there is a savings element that builds cash value. Types of permanent policies include whole and universal life insurance.

One of the strongest arguments for permanent life insurance is that if your estate is large enough to be subject to estate tax, your heirs can use the death benefit of a permanent life insurance policy to pay the IRS. If the policy is set up properly in an irrevocable life insurance trust (ILIT), the death benefit would not be counted as part of your estate.

If a living trust is set up, you could list the trust as the beneficiary of the policy. By doing so, your money would be distributed according to the terms of the trust. This allows for a disposition of the money over time, if that's what the trust calls for, or with conditions if you wanted the money distributed only under certain circumstances. However, simply making your living trust the beneficiary of the policy will not cause the death benefit proceeds to be excluded from your taxable estate. For the money to be excluded, the policy should be applied for and owned by an ILIT another party (typically your children).

In addition, the cash value in a permanent life policy grows on a tax-deferred basis, which substantially boosts the compounding power of your earnings. If you have maxed out on 401(k) plans, individual retirement accounts, and other tax-sheltered savings and investment plans, then cash-value insurance provides another alternative.

Buying life insurance is arguably one of the most important financial decisions you can make, and one of the most confusing. Whether you're shopping for term or permanent insurance, the number and types of policies to choose from can make comparison-shopping difficult, if not impossible. Before purchasing your policy, be sure to consult an expert, like those at They can help guide you and provide the personal service of unbiased life insurance professionals that can answer your questions, identify important issues and make meaningful recommendations.