Insurance Isn't Investment

Life insurance is a cornerstone of financial planning for many, either as a nice-to-have or a necessity. But learning the ins and outs can seem daunting -- there are different forms, different levels of coverage one can purchase, and different life circumstances each may fit.

This brief guide can help you make sense of the life insurance landscape -- and get a sense for the role it can play in your financial plan.

Term vs. Whole-Life Insurance

With whole-life insurance, you exchange a series of payments -- known as premiums -- for a set payout to beneficiaries when you pass away. These policies have a "cash value" -- the share of the policy you may redeem early or borrow against. Some even have growth-generating investment options for this cash value. At a certain point, it may even cover your premiums.

With term life insurance as part of your financial planning strategy, you pay premiums in exchange for a sum to be paid out only if you pass away in a given period of time -- say, in the next 10 or 20 years. There is no cash value -- if you survive the period, the policy pays nothing. Neither can you cash it in early or borrow against it.

Depending on your age, whether you have dependents and your net worth, varying levels of insurance -- as reflected in the premium size and corresponding payout potential -- may fit you best. Many who have saved and invested well over time may not need insurance at all -- they are insured by their own assets, so to speak. If your beneficiaries can get by on your savings or their income after you die, insurance becomes less important. Even if you still own a policy, decreasing coverage in order to boost your savings potential may be a wise move.

Now, some use life insurance as a part of financial estate planning, but you should be aware of estate tax rules and speak with an estate planner before presuming this is appropriate or valuable in your situation.

Beware of High Costs

Insurance-like "death benefit" riders are often attached to annuities, with high fees included. If you want to include life insurance of any kind in your financial planning, buy it separately, not as part of an annuity. Better yet, steer clear of annuities altogether.

Insurance Isn't an Investment

All insurance consists of agreements to transfer liability for potential (or inevitable) events to a third party. Life insurance companies aren't charities, either -- they need to make a profit. To simplify, you give them your money, they invest it for a higher return and offer you the security of a smaller "guaranteed" reward.

Owning a policy to cover financial dependents before your savings are sufficient is fine -- as a matter of fact, this is just what term plans are designed for. Because a payout isn't assured -- you could outlive the policy's maturity -- term insurance is usually much cheaper. And as a wealth-accumulation strategy, odds are you could do far better than whole-life insurance.

Here is a good rule of thumb: The fancier the product, the more you'll pay. This goes for life insurance, too: Many plans are very pricey and restrictive, particularly those that offer investment options (usually called universal or variable life products). These split your premiums between cost of insurance, investment and fees. Complicated products eat away at the purchasing power of your premium. In most situations, your financial planning will be better served by buying term life insurance and then investing outside of the insurance contract.

Life insurance policies are often sold based on fear -- the fear of leaving one's family in a tough spot if you pass away prematurely. That is a very valid concern, indeed. But make sure you size up the options soberly, and determine whether they actually fit your financial goals and needs.