Life Insurance Guide

1. What's Life Insurance?
Life insurance, it turns out, is the wrong name altogether. What we're really talking about here is death insurance. If you die, the people you've named as heirs in the policy get some money. Simple as that.

There are two main kinds of death, err, life insurance:
1. Term insurance - You buy this policy for a specific period of time - usually 10 to 30 years. You pay a monthly premium, say $50, for $750,000 of coverage over 20 years. Then, if you die during that term, the person you named as the beneficiary of your policy gets that $750,000, tax-free. If you live beyond 20 years, the insurance company keeps your premiums and you don't get anything.

The vast majority of people reading this guide ought to have term insurance.

2. Whole life insurance - You can keep this life insurance for your whole life if you want, not just for a specific term. Like term insurance, the policy comes with a death benefit, but there's an investment component to it too. You can borrow against the invested money while you're still alive and draw on it later in other ways too.

Whole life sounds great, right? Well, these policies cost a ton more and have sky-high recurring fees on the investments. For all but the wealthiest people (mostly older, at that), whole life makes no sense. You can do far better by buying some term insurance for $50 a month, then investing the extra $150 you would have spent on $200 whole-life premiums in some low-cost index mutual funds.

2. Do You Need Life Insurance and How Much Do You Need?
People who should have it:

• People with kids
• People with disabled siblings or destitute parents who rely on them for financial support
• People with spouses that do not work
• People who are married, don't have kids and want to give their spouse the financial freedom to mourn

People who shouldn't have it:

• People who aren't married and have no dependents
• People who are married, both work and have enough savings to shield a surviving spouse from financial peril in the event of a death
• Kids (unless they're child actors or do something else that contributes a lot to the family budget)

Sorting out how much life insurance you need is a little like figuring out how much long-term disability insurance to buy. It's income replacement - except the person whose income you're replacing no longer needs to be supported (because they're dead). Instead, it's just the survivor who may need financial help.

But how much help might they need? And for how long? To figure this out, you'll need to answer a few things:

• How much money does the insured person take home (after taxes, since this is what insurance would be replacing - life insurance proceeds are not taxed)
• How much money does the spouse who would be the survivor earn? How much could they earn if they needed to work (and support surviving children)?
• For parents raising children alone with no other parent in the picture, who would take the children in and would their guardians need financial assistance?
• How much money is in savings, whether it's immediately accessible or in retirement accounts?
• What would the surviving spouse need to retire comfortable someday?
• Do you want the life insurance proceeds to pay off any outstanding mortgage?
• Do you want the life insurance proceeds to pay for the college costs of the surviving children?

You can see where this starts to get confusing. Plenty of people throw up their hands and simply attempt to replace five or ten years of their income with a term life insurance policy. That's much better than doing nothing. This basic calculator will help you get at this number. This more complicated calculator takes future expenses like living costs, educational costs, and medical bills into account.

3. Advice on Buying Life Insurance
Again, you may not have to buy it. Your employer may offer some for free, though it usually won't cover more than a year or two's worth of salary. You may be able to buy more, but unlike disability insurance, the deals here often aren't that great and you could probably do better on your own.

If you already have a relationship with an insurance company then check in with them to see if they offer a discount for bundling services. Or you can search our directory top rated insurance companies here or look for an insurance agent here.

Insurance brokers often push whole life insurance policies because they get paid better commissions for selling these policies. But remember what we said and stick to your guns - term life policies make the most sense for most people (unless you're a rich, wrinkled sugar-mama or papa).

If you're young and relatively healthy, you should be able to pick up a million bucks worth of coverage for $50 a month. It's good to buy while you're still in good shape so you can lock in these lower rates. But don't even think about pretending to be younger or healthier than you are. If an insurance company finds out you lied (and they do have investigators) then your whole policy will be void.

Before you can get a policy, the insurance company will send someone into your home to take your blood and have you pee in a cup. If they find anything even remotely odd, they'll raise your rate first and ask questions later. So you really do have to be in perfect health to get the lowest possible rate, like the ones you see advertised in magazines all the time.

One more thing: Since you may well be sending money to your life insurance company for 20 year or more, take a quick look at the company's financial stability before you buy a policy. There's no guarantee that the rating sites like A.M. Best, Fitch Ratings, Moody's and Standard & Poor's won't miss something important, but it's better than accidentally ending up with an insurance company that all of the rating firms believe is kind of shoddy.

It's not too common for an insurance company to go belly up. But your policy will probably be OK even if your insurer fails. Under state law, policyholders get their money before other creditors get paid. Plus, insurance companies have created pools of funds called local state guaranty funds as another form of protection. Usually life insurance death benefits are extended $300,000 worth of coverage by these funds. Bret Arends wrote about these protections during the AIG debacle.

4. Grilling Guide: Questions to Ask Before Buying Life Insurance
What is the surrender charge?
Policies usually charge you for cancelling your policy. How much will it cost you?

What are the renewal terms? Is the policy "convertible"? (Ask this if you're buying a term life policy.)
Find out how you can renew the policy after it expires. Also, see if you can convert it to a whole life policy down the line. Sometimes you can do this without going through another doctor's examination.

Can I take a loan out against my policy?
This usually isn't the best idea. But you should know whether you can take a loan against your policy, how much, for how long, and how much interest they'll charge you.

How are claims handled?
Ask about their process for handling claims. If they make it sound onerous while trying to sell you the product then it's probably overly onerous.

What's the insurance company's financial rating?
You're looking for an A+ rating here.

What fees and commissions do you collect for selling me this policy?
Keep your insurance agent honest if you're using one. Be sure your agent's interests are aligned with yours - or at least understand where they part ways.