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How to Choose the Right Life Insurance

Choosing the right life insurance should cover 2 major criteria:

1. What Should the Benefit Be?

2. What Level of Premium Can I Afford?

Benefit Level

Generally, life insurance is purchased with an eye towards protecting your family, and specifically your dependents.  Typical dependents include children and depending on the household, your spouse.  Many (probably most) households these days are budgeted for 2 incomes, so while your spouse is not really a dependent in this case, you do need to account for the loss of income, should you pass away.

As a general rule of thumb, I like to calculate 10 years of salary into the benefit.

Then of course there are other considerations:

  • Mortgage
  • College Education(s)
  • Will Your Spouse Be Able to Handle Extra Responsibilities

If you are a single parent, you should calculate cost to care for your children through to adult hood and reasonable college expenses.  If you think your kids are going to an average college then estimate $125,000 each. If you want them to go to Harvard, calculate $500,000+ each.  If you can afford to leave them a little extra money in a trust beyond living and college expenses, this is a nice thing to do.

Typically in the case of children one should calculate cost of care to adulthood from current day forward and any extra money left over (as there will be because of the aging of the children) will get rolled into a trust for them.

I would calculate $10,000 – $20,000 per year for costs of raising a child. Set this up to go into a trust to be distributed annually to the caretaker of your children and then roll over to the child’s trust when they turn 18.

All of your distribution plans for the benefit should be spelled out clearly in your will.

Once you’ve calculated the benefit level you’d like to achieve, then it’s time to start looking at premiums and types of insurance.

Premium Level

The cost of your life insurance premium will be determined by 4 primary factors:

  • The Type of Insurance (Term or Whole)
  • The Benefit Level
  • Your Age (and to a degree health)
  • Term Length (if term type insurance)

Most people choose term life insurance over whole life insurance because of a concern over cash flow – and maximizing benefits.  That is to say, for the level of benefit (payout amount) term policies will typically have much lower annual premiums than whole life policies. See the above links for more details regarding term vs whole life insurance.

The counter balance to the low cost of term life insurance, is that, unlike whole life insurance, you will only receive the benefit payout if you die during the term of the insurance contract.  If you survive the contract (fingers crossed) that’s it, the insurance company has no further obligation to you.

When considering a whole life policy it is not uncommon for individuals to decide to start saving and investing the money themselves.  The thinking being that for a whole life policy, if you save and invest your self, then you don’t have to pay the profit to the insurance co.  The major flaw in this thinking relates to the efficiency of investing – it is likely that the insurance company can create much greater leverage with your money, than you can, thus earning more per dollar and in the end likely to return more of this to you. You can get in on the action directly with a Par Whole Life Insurance policy see: whole life insurance.