The topic of life insurance is one that many do not like to discuss. The reason is simple – it involves death, most notably our own. And since death routinely shows up on lists of common fears, its obviously something we choose not to think about.
Next to purchasing quality health insurance, I believe this is the second most important insurance a person should buy. I feel this way because there is nothing you can do about it once you are gone. You can’t buy a life insurance policy after you are dead. You can’t provide any financial comfort to those left behind once you are in the ground.
See what I mean about life insurance? Even writing those sentences brought a tinge of emotion I’d rather not feel. That’s what makes it so easy to avoid dealing with this.
But we have to. Life insurance is a big piece of the puzzle to our financial lives – even if we, as the deceased, will never see any of the money.
What is Life Insurance?
Just like all insurances, life insurance is a contract between you and an insurance company. The terms of the contract call for you to pay a monthly premium (payment) to the insurance company. In exchange the beneficiaries you’ve designated will receive a lump sum payout after you die.
Usually those beneficiaries are left behind family members like a wife or children.
The goal of life insurance is to provide the beneficiaries a measure of financial security. It’s going to be a traumatic enough time dealing with the emotion of losing a loved one. The last thing people need is to be worrying about their personal financial life.
Do I Need Life Insurance?
Some of you are already asking, “But do I really need it? I’m healthy and going to live a long time. Seems like a wasted expense.”
I won’t jump on you for being insensitive. That’s actually a great question to ask. Here’s a simple exercise that will help answer the question.
Imagine yourself gone tomorrow. OK…have the picture. Now answer these questions:
- Who is counting on you right now for financial support?
- What joint account holders will inherit your debt when you die?
- What future plans do those counting on your financial support have?
- Can those left behind adequately fend for themselves with no help from you?
- How will you pay for funeral expenses?
Of course the answers to those questions will be different depending on the person. Let’s take a look at a few scenarios.
Scenario #1: The Single. The majority of singles do not need a full-blown life insurance policy. They have not yet established their own family. So they do not have a spouse or children with future hopes and dreams who are counting on financial support.
A single’s debt is his or her own. In almost all cases, outstanding debt cannot be passed on when you die to parents or other loved ones. (One of the exceptions would be for someone who has cosigned a loan.)
The only real issue for the single is how to pay for funeral costs. The extended family would obviously do that. However, it would be a kind gesture to leave money for that expenditure so as not to burden the family. In that case, a single person should consider purchasing a minimal life insurance policy designed specifically to cover funeral costs.
Scenario #2: The Newly Married. The newly married couple with no children might face new situations that would call for the purchase of a life insurance policy. But it still isn’t a given yet whether either spouse should purchase one.
Often both spouses work. So if something happened to one or the other, the surviving spouse could still make a living.
However, liabilities could begin to factor into the equation here. If the newly married couple has jointly taken out vehicle loans or signed for a mortgage together those debts will still need to be covered by the other in the event of a death.
And if they have not yet adequately funded an emergency savings fund the funeral costs may be a challenge to cover.
Generally speaking, the more risk taken by the newly married couple – or any couple without children – the more a life insurance policy makes sense.
Scenario #3: Married with kids. Of all the life scenarios this one alone should be answered with a definitive “Yes.” If you have kids, life insurance is a must. To ignore it at this point is negligent and irresponsible.
My wife and I took out our first life insurance policy when our first child was born. At the time, I was the main breadwinner in the family. I felt very uncomfortable thinking that my wife and new daughter would have to worry about money if I was gone.
I wanted my wife to have financial flexibility to make wise choices in the present. If she wanted to keep working, fine. If she wanted to take time off and live off the lump sum payout while my daughter was still an infant, I wanted her to have that option.
But it wasn’t just about the present. I wanted my daughter’s future to be taken care of as well. There would be grade school and clothes and activities and college and a wedding and countless other things that would require money. I could have the peace of mind knowing those important things could be covered by the payout of my life insurance policy.
Since then we’ve had three more kids and have chosen to up the payout on my policy twice. In addition, we’ve purchased a policy for my wife (with the same payout) now that she works full-time.
Our goal is to leave no doubt should one of us pass away that the remaining family members would be taken care of and then some. I sleep very well at night knowing that is the case.
Scenario #4: The Retired Couple. For the retired couple, holding a life insurance policy goes back into the maybe column. This time period is similar to the newly married couple in that most likely there are no children in the home as they have left and established families of their own.
There may still be debt issues and lifestyle choices to consider as well as additional medical costs that occur as they age.
However, if a couple in their sixties or seventies has been saving diligently, paying off debt and investing wisely for 30+ years, they may have accumulated enough wealth to self-insure. What I mean by self-insure is that they have accumulated enough money to carry them through the rest of their lives. Should one spouse pass away the survivor could live off the accumulated assets.
So, in that case, continuing to pay for and hold a life insurance policy would be irrelevant. There would be enough money already to live on.
To sum up, whether or not to purchase a life insurance policy depends on your life circumstance. The more risk you have taken on and the more people who are counting on you for financial support are the two biggest contributing factors to weigh.
How Much Coverage Should I Have?
There is no cut and dry answer for how much life insurance coverage to purchase. Remember, the purpose of life insurance is to replace income so that your dependents will be able to maintain their current lifestyle in case you die. So obviously it will be a personal decision that will vary from household to household.
A starting point that many consider a good rule of thumb is to have at least 10 times your annual salary in coverage. For someone making and living off of $25,000 a year, that would translate into $250,000 of coverage. In theory, that would fund 10 years of expenses going forward for the dependents.
However, it’s not that cut and dry. The “10 times” number should only be considered a starting point – the bare minimum to secure. There are factors to consider that might spur you on to purchase more coverage.
For example, let us consider the time factor. Ask yourself, “How long will my dependents need financial support?” A family with infants or preschoolers may have 15+ years before the children are out of the home whereas those with a teenager may only have 5.
You could also look at the time factor in relation to retirement. How long is it to retirement? 10 years? 20? 30? Will your dependent need financial support all the way to retirement where he or she will then be able to draw on other assets like social security to survive?
The longer the duration to either of these milestones should challenge you to think about more coverage.
Let’s think about education. Are your children in private schools where you are paying tuition? Do they plan to attend college?
Once you are gone, will your dependent need to return to school to seek a degree that will lead to a career? If so, will he or she need childcare?
What about mortgages and other debt? How will that be paid?
And don’t forget about inflation, a rise in prices that reduces the purchasing power of money. $25,000 in year one after your death will not purchase the same amount of goods and services ten years later. Thanks to inflation, in ten years $25,000 may only be equivalent to $20,000 (or less).
When it comes to life insurance coverage, the key is that the dependents receive enough to have flexibility of choices.
Thinking like that changes the equation. I don’t want my family forced into decisions they otherwise would not have made because I chose to skimp on life insurance. I don’t want them going into debt, or missing college or going back to work if they really don’t want to.
I want my wife and four kids to have life options without worrying about how to fund them. So the “10 times” number really doesn’t work for us. We’ve chosen to have quite a bit more than that on my policy and on my wife’s policy. The higher yearly premium we pay for the added coverage is worth it to us.
The Types of Life Insurance
There are two main types of life insurance policies on the market today: term life insurance and whole life insurance. In this section I’ll give a general overview of each kind and offer some comparative analysis with a list of pros and cons.
Term Life Insurance
Term life insurance is so named because it lasts for a specified length of time. In other words, it’s only valid for a certain number of years. The term (the # of years) will vary depending on the policy you purchase. Once that length of time has passed the policy expires.
If I die before the term is up my beneficiaries get the payout according to the provisions of the policy.
If no claim has been reported to the insurance company during the years of the policy – which in essence is a good thing because it means I haven’t died – then the policy expires. I’m left without life insurance or I have to renew/find a new policy to carry me forward.
How that actually looks can be seen in this example:
A 35-year old man with a wife and two kids making $50,000 a year decides he wants life insurance coverage until he’s 55. He figures that will at least provide an income stream until his kids graduate from college. So he begins researching 20-year term life insurance plans.
Using the basic standard of 10 times his income, he finds a policy that will payout $500,000 in exchange for a yearly premium of $400 to the insurance company.
If he dies at anytime during the 20 years his family (beneficiaries) will receive a $500,000 lump sum payout. If he does not die, the term will expire worthless and he will have paid the insurance company a total of $8,000 in premiums ($400/yr. times 20 years).
Whole Life Insurance
Whole life insurance is so named because it lasts your whole life. (This is also sometimes called universal life, or cash value or permanent life insurance.) There is no term that expires. Once you have the policy in place there is no need to renew it or find a new plan.
So using the example from above, the beneficiaries of the 35-year old man would receive the $500,000 payout no matter when he died – at 45, 55 or 95.
Another facet of whole life policies is that the insurance company sets aside a portion of your yearly premium into a savings account with the insurance company. The cash they put into this savings account grows over time as they deposit more each year and interest accrues on the money.
If at some point you become financially independent and no longer have a need for life insurance, you can cancel the policy and stop paying the premium. At that point your beneficiaries would no longer receive the $500,000 lump sum payout when you die. However, the insurance company would award you the cash saved inside your whole life policy that had accumulated over the years.
Pros and Cons: Which life insurance is better?
Of course there is debate in the space as to which type of life insurance is better. Here’s a look at the major pros and cons for each.
- Simple product to understand – so comparison shopping is easier
- The market for selling the product is competitive, which provides value for the consumer
- Most affordable type of life insurance – very inexpensive
- Great for younger individuals looking for protection against loss of income
- The policy eventually expires and the coverage ends
- Premiums on a brand new policy become more expensive when you get older
- A person may be unable to get insurance after a certain age or as health declines
- Builds no cash savings account
Whole Life Insurance:
- Guarantees coverage your entire life
- Provides a forced savings account
- The cash in the savings account may be borrowed against (tax free) to provide funds for other financial goals (like education)
- Premiums do not increase with age or decline in health
- Premiums are significantly higher than term policies
- Upon your death, beneficiaries do not receive the cash saved over the years in the policy (they only receive the payout amount)
- Services are heavily fee laden
- Potential for conflict of interest as insurance agents collect large commissions for sales of whole life products
Which is right for me?
For my money, term life insurance policies represent the best value for the average consumer. These policies are significantly cheaper than whole life ones and therefore are providing the biggest bang for your buck based on what you are paying.
Furthermore, I can use the annual savings to my benefit.
That $500,000 life insurance benefit that cost me $400 per year with a term policy may cost me $3,000 a year with a whole life policy. That’s a big difference. I can take that difference, invest it in quality growth stock mutual funds and in 20 years time have quite a decent amount of money at my disposal.
Of course, these are just examples and actual rates will vary depending on what you can find. I would not overpay for life insurance though, nor would I want to pay heavy fees or commissions to an insurance agent or company. As some suggest, there may be certain variables to consider that might make a whole life policy make sense. But for most it’s not a win.
(For those of you who are visual learners, here is an excellent 14-minute video from Kahn Academy explaining the basic difference between term and whole life policies.)
6 Steps to Getting a Life Insurance Policy
The process whereby you will come by a life insurance policy can be daunting – but that doesn’t mean you should avoid it. You have so many options as far as policies go and so many companies vying for your business. It will take some time to work through the process so be prepared.
Basically you will have to go through 6 stages to secure a policy:
Stage 1: Determine what type of coverage you want
This is where you will determine what type of coverage you want. What are your needs? What type of policy best fits those needs – term or whole life? How long do you think you will need coverage? How big do you want the payout to be?
This is a heavily intensive research phase that you should spend considerable time on. Talk with your significant other. Read about the different type of plans. And be sure to check your monthly budget to see how much you actually can afford.
Stage 2: Request quotes online from several sources
Once you’ve decided on the type of plan, it’s time to request some quotes. Fortunately, it doesn’t necessarily mean calling around to a bunch of insurance agents. Requesting quotes is easy thanks to the Internet. (If you don’t have the Internet find a friend or family member who does…or go to the library…or go buy a money magazine – most likely you will see many ads of companies selling life insurance in those pages.)
Of course you can go directly to the insurance companies website or find a broker. However, third-party sites have developed that allow you to compare quotes from a variety of companies at once. Sites like Insure.com, 1stOptionInsurance.com, AccuQuote.com and PolicyGenius.com all help streamline the process for consumers. (Here is an in-depth review of PolicyGenius at CashCowCouple.com)
As you request quotes, you will most likely be asked a series of questions related to your age, current health and family history. It may be tempting to fudge the numbers a bit but be truthful in these surveys. Insurance companies use certain health variables to determine whether they will cover you and ultimately figure out your rate. It does you no good to lie through this process hoping your medical history won’t be discovered.
Stage 3: Choose your company
Once you receive the quote information it’s time to choose a company.
The tendency here will be to choose the cheapest premium. Rather than look at the premium itself take it into consideration with other factors as well.
Do research on the particular company you are considering? What is the rating of that insurer? How are consumer’s attitudes about the company – has there been many complaints? What is their overall service like – can they be easily reached with questions?
While price is important these other factors should way into your decision. In the end, pick a well-established company that is highly rated and has a good track record based on consumer feedback.
Stage 4: Prepare for a health exam
There may be some insurance companies that accept the answers to your health questions that you filled out on the application. Most though will want to conduct their own medical exam. The life insurance agent will arrange for a licensed medical technician (contracted by the insurance company) to meet you at a clinic or even in your home to conduct the exam.
During the life insurance exam I took at my home the technician:
- reviewed my medical history (including lifestyle habits such as exercise, drinking, smoking, high risk hobbies, etc.)
- asked about my family’s history
- read my blood pressure
- took my pulse and listened to my heart
- confirmed my height and weight
- took blood
- retrieved a urine sample
All that may seem obtrusive but again it’s part of the process. And really, when you consider what might be at stake for your family, it’s really no trouble at all.
Stage 5: Turn in a finalized application
At this point your finalized application can be turned in. Often this is simply given to the people who took the exam. They pass it on to the insurance company.
All insurance companies have people known as underwriters. They review the application and the medical exam, factoring in as much information as possible. It’s their decision to insure you or not and if they choose to, figure out how much it will cost them to do so.
They write the policy and send you the terms, along with the payment rate they have figured.
Stage 6: Pay your premium upon approval
If you have been approved and the terms of the policy are to your liking, then it’s time to pay the premium. Once that is done you are covered as long as you continually pay your yearly premiums.
Tips to Save Money on Life Insurance
Just like all other insurances we want to try and save money here. I don’t mind paying for a policy but if there is something I can do to reduce the premiums while keeping the same payout then I need to look into that.
Of course I can’t do anything about my age. Nor can I change my family history. Those issues I just have to accept as part of the equation to my insurance premiums.
However, your current lifestyle is a HUGE part of the equation. Here we can make adjustments. We want the insurance company to see we are committed to our health and safety, which ultimately leads to a longer life (and subsequently more premiums and less payouts for the insurance company).
Here are a few tips for saving money on life insurance as it relates to lifestyle:
- Reduce alcohol intake or eliminate it altogether. Drinking less means you are less of a health risk and the insurance company will reward you with a lower premium.
- Stop smoking. This is a similar issue to alcohol intake. A non-smoker is more likely to live a longer life. The insurance company will therefore be less likely to fund a payout to a beneficiary, especially for a person with term insurance.
- Lose some weight. Excessive weight can lead to a host of problems including high blood pressure, higher cholesterol levels, heart related issues and diabetes. Improving in this area makes you a better insurance risk.
- Exercise regularly.
- Be a good driver. Believe it or not insurance companies can up your rates if you have too many tickets or traffic accidents. It’s not just automobile insurance that poor driving affects.
Here are a few non-lifestyle tips that can help you reduce your premiums:
- Switch insurers. After having gone through so many steps to finalize our policy, there is a tendency to – as they say in the Northeast – “Forget about it!” It was such a hassle to get in the first place we don’t want to go through some of those steps again.
But just like all insurances this should be reviewed on a regular basis (no more than once a year). You may find a company with a cheaper product than the one you hold.
- Switch from whole life to a term policy. As stated previously, term insurance is significantly cheaper than whole life. You could secure big savings and use the freed up money for other financial related issues by switching plans.
- Remove all riders from your policy. An insurance rider is essential an addendum to your policy that provides added benefits. For example, if you had an accidental death rider built into your plan, the insurance company would pay more to the beneficiaries if your death happened as the result of an accident. Of course, you’ll pay more to have this rider added to your policy.
- Keep credit in good standing. Pay your bills and credit cards on time and keep all other lines of credit in good standing. Insurance companies can review your credit report when determining your rate.
A Touchy Subject That’s Worth the Money
Thinking about that time when we will no longer be alive is a task we’d rather avoid. But dealing with our own mortality is what securing a life insurance plan is going to cause us to face.
The fact of the matter is that we are all going to die. Sometime, somewhere it will happen.
I don’t know when my time will be up. But what I can be sure of is how those left behind will fare once I’m gone. I consider my life insurance preparations as a token of love to their well-being.
Thinking about it that way makes the money spent on the premiums well worth it.
Questions: When did you get your first life insurance plan? Why? What type of life insurance plan do you have now? Have you switched plans recently? If so, what was the process like? For the cost, do you see any benefits to whole life insurance? Do you have any riders on your life insurance plan?