Life insurance, strangely enough, is one of those topics that can lead to passionate disagreement (despite it's basic premise). There are many different theories on what type of life insurance people should choose and how much of it they should have. There is no right answer to these questions (as each person's situation and goals are different), but here is our take on the subject.
First, we do not believe that life insurance should be used as an investment. Often times life insurance agents sell whole life as a conservative bond portfolio and variable life as an investment due to its tax deferred nature. However, life insurance should only be used when there is a need for a death benefit; that is, when you foresee the need for funds available at your death. Life insurance was never meant to be an investment, but if used and understood properly it can greatly reduce your risk of illiquidity should you die prematurely. It is a hedge.
The original idea of life insurance was a beautiful one. A community comes together with the awareness that some people will die earlier than they are supposed to and some will live past their life expectancy. Since we do not know who will live past their life expectancy and who will not the community pools their money together to take care of the families of those that pass early. Things have changed a little from the original idea, but there are a lot of similarities.
Life insurance is the best way to provide liquidity at death, which can be vital for a variety of reasons. If you have a significant estate liquid assets might be needed in order to pay estate taxes. Frequently those with large estates have much of their estate in illiquid assets such as real estate or a business. The great value of life insurance in these situations is that it is available very quickly and does not have to pass through probate. The cash can be used to live on, to pay down debt, or even to pay estate taxes so that other assets do not need to be sold off. For those who are still building their wealth and want life insurance to protect their family this liquidity can also be very important. A family that loses its breadwinner may find that the deceased's assets are parked in qualified plans and real estate. The funds from the life insurance can be used to pay down debt and/or for living expenses. These funds can then be investing in income producing assets that help to replace the lost income of the person who was insured.
There are a lot of traditional financial planning resources that give information on calculating how much life insurance you need. The real question we would pose to you is how much life insurance do you want? Many people try to get as little insurance as possible believing that their spouse would go back to work or that the family could move to a less expensive home, etc. Many people have a hard time thinking about their family going on without them and so they want to expedite the life insurance process. You should stop and think about what you would actually want for your family, not just what they might need. If your children were dealing with the trauma of losing a parent would you want them to also have to move from a familiar home, or would you want your spouse to be a single parent going back to work when he or she had not worked for several years, perhaps decades? Is there anything wrong with providing more insurance than what would give your family a minimal life style? Manifestly, it makes sense to provide your family with the most you can give them, because if you were not there you would want to provide for them what you would have had , had you survived. When people actually stop and think about this they often come to the same conclusion.
The type of insurance you may need depends on how long you anticipate needing a death benefit. There are two basic categories of life insurance, permanent and temporary. An example of permanent life insurance is whole life insurance. Temporary insurance is often referred to as term insurance. If you have a need for insurance now, but do not anticipate needing it forever then term insurance may be something you should consider. Permanent insurance can get a little more complicated, as there are many varieties and different companies, which sell it in different ways. Term will be significantly cheaper than permanent insurance, but not if you need the coverage for a long period of time. Life insurance has been aptly compared to real estate. Term insurance is like renting - for the short term, whereas permanent insurance is the equivalent to buying a house. Having said this,, if you do not need a permanent death benefit then you are putting a lot of your funds into a policy for little reason. If you know that the day you die your survivors will need liquidity or are sure you want the death benefit to be there, then a permanent policy may be for you.
When looking at permanent policies a good rule of thumb is to avoid variable policies. Variable policies allow you to use the cash value that builds up in the policy and invest those funds into various mutual funds. The problem with this is that you are using a product that is meant to reduce risk and act as a hedge, which you are now putting it at risk. Whole life could also be called traditional insurance. With whole life insurance you get a fixed premium that you are theoretically supposed to pay until you die. The death benefit is set to grow slowly and much of this growth comes down to the dividends the company is able to pay, assuming they are a mutual company. In this regard, do yourself a favor and do not even consider buying whole life from a publicly traded life insurance company. Universal life is another option, it gives you a choice regarding how much to pay into it. The problem that many people run into is that they under fund the policy for too long and it implodes. Depending on your needs, and this is beyond the scope of what we are getting at here, the flexibility of universal life could be really helpful.
There are many providers of life insurance, but not all of them will stay sound over the course of time. By nature, a life insurance policy could cover decades, nearing, perhaps, a century. Thus, when buying a policy you are taking on the company's risk. Recent financial markets have shown us that even the most well respected and sound companies are not impervious to financial instability, poor management or the fluctuations of the U.S. dollar, etc. You want to buy from as strong a company as possible, one that has a history of making good decisions. There is no guarantee that they will continue to make strong decisions, however they are more likely to do so than a company that has not existed for as long or has had poor decisions in their past. You can get some information on insurance carriers from the ratings agencies, however keep in mind that these are the same ratings agencies that clearly had Wall Street pegged very inaccurately. If an insurance company goes under that you have a policy with there is some protection from the government through funds set up in each state, however the levels of coverage are not all that high and vary by state.
There is a lot to the life insurance decision process and this is not meant to be a complete assessment, but rather it is an attempt to give you an idea of some of the things you should think about that an agent generally will not bring up. Foremost, it comes down to accurately assessing risks and acting in a rational and prudent manner.