Keep Life Insurance Simple

Often, simple things do the job best. But that'll never stop people from trying to improve on simple things. And while some of those efforts bear fruit, you're often be better off with the original.

Take life insurance. As a concept, life insurance is a helpful tool to have. In exchange for a relatively small premium, you can protect your loved ones from the financial risk of your death. Unlike most other assets, where your returns tend to increase over time, basic life insurance pays the same amount whether you die tomorrow or 20 years from now.

If this basic type of coverage -- also known as term life -- were all you could get, it'd be simple to buy a life insurance policy. But if you try to buy a policy, you'll likely run into several other types of life insurance with other characteristics. Even though some of those bells and whistles can be valuable, most people would be better served with a simple term policy.

The old insurance proverb
When it comes to buying life insurance, the quote you'll hear again and again is "buy term and invest the rest." To understand what that saying means, you have to look at the history of insurance.

For decades, you could buy two types of insurance: term life and whole life. Whole life had higher premiums than term life, but whole life policies were designed to have a cash value that would rise over time. Unlike term life coverage, which simply disappeared once you stopped paying premiums, whole life offered a payback even if you didn't die while you owned it.

Illustrating the problem
Over time, options for life insurance have multiplied. Universal life has given people more flexibility in paying premiums. Variable policies allow you to go beyond fixed-income, linking returns to stocks. You can also choose among a vast array of riders and add-ons to get additional guarantees on investment returns and payout amounts.

As a consumer, it's easy to get bogged down in the details. For instance, when you consider a more complicated policy, you'll inevitably receive policy illustrations. These tools are supposed to help you understand how policies work.

But illustrations have to use assumptions about how the policy will behave. They include things like the return on your investment and prevailing rates in the market. Often, reality throws you for a loop, and those assumptions turn out to be incorrect. That can force you into things you're not prepared for, including having to pay additional premiums or accept smaller amounts of coverage. Especially with variable policies, it's hard to come up with assumptions that cover every contingency.

Over the years, problems with cash value insurance have led to many lawsuits. Companies like Lincoln National (NYSE: LNC  ) , MetLife (NYSE: MET  ) , and Prudential (NYSE: PRU  ) settled with policyholders who made allegations of deceptive sales practices. Many insurance companies also got fined by state insurance regulators.

Know what you're getting
It's true that more complicated life insurance policies have positive traits. Any income from investments within a policy is tax deferred, and the death benefit payout to your heirs is free of income tax. And for certain estate planning purposes, cash value policies can be useful.

But no matter what you think of the other reasons to buy term life, the simplicity makes it an appealing choice for most people. As long as you pay your premium, you'll get the coverage you need to protect your loved ones. And you won't have to worry about whether some obscure provision of a more complicated policy will give you or your family an unexpected surprise.

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Learn more about the term vs. cash value insurance debate, along with other insurance basics, in our Insurance Center.

For more on protecting your finances with insurance, check out our personal finance service, Motley Fool Green Light. You'll find great resources to understand insurance better and find the best coverage. Take a free look with our no-obligation 30-day trial.

Fool contributor Dan Caplinger is a big believer in term insurance. He doesn't own shares of the companies mentioned in this article. The Fool's disclosure policy needs no illustrations.

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