What You Should Know to Ensure Your Loved Ones Will be Taken Care of Use our simple Insurance Needs Calculator
Use our simple Insurance Needs Calculator
Today, we are virtually inundated by ads telling all of us to buy life insurance. However, before buying life insurance, there are a number of questions parents should answer for their own family and circumstances.
Do you really need life insurance at all?
What are the differences between the various life insurance products available today?
How do I determine what type of insurance is right for me?
How much life insurance should I buy?
When should I increase the amount of life insurance I already have?
Should I count the insurance I get through work when doing a life insurance needs analysis?
Are there any situations in which I should consider buying cash-value life insurance?
You need life insurance only if you need to “leave behind” income when you die. Ask yourself the following question: “If (heaven forbid!) I were to die tomorrow, with the loss of my current income would those who are financially dependent on me be able to continue to afford to pay for those things they’ll need to pay for (such as mortgage/rent, medical insurance and all other general living expenses, college education savings, etc.)?”
If the answer to this question is no, they couldn’t afford to pay for what they’ll need to pay for, then you need life insurance. If the answer is yes, they could afford to pay for what they’ll need to pay for (either because they are not financially dependent on you, and/or because, without life insurance, the assets, savings and earnings you leave behind or the assets and earnings of your spouse or other dependents you leave behind would be sufficient), then you don’t need life insurance.
Remember, however, that some forms of activity – while not “earning an income” – do have an economic value, and need to be insured for. So, for example, because the death of a stay-at-home mom or dad would cause an economic hardship (daycare fees or decreased earning time for the surviving spouse), a non-income-earning spouse in a family with other dependents should be covered by life insurance.
What are the differences between the various life insurance products available today?Although there are numerous variations of each, basically there are two types of life insurance policies available: term and cash-value.
Term – Term life insurance is the simplest type of life insurance. With term life insurance, you pay a premium (usually yearly or monthly) over a set period (for example, 10, 20 or 30 years). With some policies (“increasing term”), the premium goes up over the term of the policy; with others (“level term”), the premium remains the same over the term of the policy. In return, if you die before the term of the policy is up, the insurance company will pay your beneficiaries a set sum of money (the “face value” of the policy). When the time period (term) of the policy ends, your payments (as well as the coverage) ends, unless you choose to renew it.
Term policies can be further divided into two main types:
• Level term life insurance, in which both the premium and the death benefit on the policy remains the same throughout the term of the policy.
• Decreasing (or declining) term insurance, in which the premium remains the same, but the death benefit gradually declines over the life of the policy. Mortgage life insurance is usually a declining term policy. And, because the death benefit declines and the death benefits often must be used for a specific purpose – that is, to pay off a remaining balance on a mortgage or other loan – declining term life insurance is virtually never a good buy.
Cash-Value – Cash-value life insurance policies combine life insurance with a savings or investment element. As with term insurance, you pay regular premiums on the policy, and, if you die while the policy is in effect, the insurance company will pay your beneficiaries a set sum of money. Unlike term insurance, cash-value policies remain in effect for most or all of your life, and, in some cases, after a period of years, you can stop paying premiums on the policy (even though the policy remains in effect). Generally, there are three types of cash-value policies:
• Whole life insurance, in which premiums generally remain the same over the term of the policy. A portion of the premium pays for your insurance, while a portion is put into a “savings account” (the “cash value” of the policy). How much interest that is paid on this cash value does not have to be disclosed by the insurance company. Moreover, the only way to access this cash value is to borrow against it or cancel the policy.
• Universal life insurance, which is very similar to whole life insurance. However, with universal life policies, the amount of your premium going toward savings, and how much interest is being paid on those savings, is disclosed to a larger (but not complete) degree. In addition, because of the numerous fees and expenses that are charged on universal and whole life policies, the actual cash value of the policy (as well as its rate of growth) is often much less than it seems.
• Variable life insurance is virtually the same as universal life policies, with one major exception. With universal, the insurance company chooses where to invest the “cash value” of policyholders’ accounts; with variable life, you get to choose from a number of investment vehicles (usually a mixture of mutual funds, bonds, stocks and money market funds) and, therefore, the degree of risk that the investment (or savings) portion of your policy takes.
This leads us to our next question: Are life insurance products that include an investment component a good purchase?
Are cash-value life insurance policies a good purchase?
Despite what many of their marketing material would have you believe, whole life, variable and universal life insurance policies (policies that include a savings or investment component) are generally not a good purchase for two reasons.
First, a very large portion of your premiums are deducted to pay sales fees and other “expenses” charged against the policy. So a relatively small portion of your premium ends up going toward savings or investment.
Second, the premiums on cash-value policies are much higher than those on term policies. For example, a term life policy for $350,000 that would cost $450 to $500 per year in premiums would cost as much as $4,000 per year in premiums as a whole life policy. As a result, many people who buy cash-value policies cannot afford the amount of insurance they need, so they end up being underinsured.
Most people can afford the amount of insurance they need only by buying a term policy since the premiums on cash-value policies are so high. For those to whom cost is not a concern, cash-value policies are, at best, only mediocre as an investment (due to the fees and expenses charged). So, in virtually all cases, you’re better off buying the much less expensive term policy, then taking the savings on the premiums and investing those in the mutual funds, stocks, bonds or money market accounts of your choosing.
When buying a term life policy:
• Be sure to purchase a level term policy, so that your premiums will remain constant.
• Be certain that the policy is for a minimum of 20 (preferably 30) years, so that by the time the policy term ends (in most cases), those who have been financially dependent on your income no longer are. Of course, there is the possibility that you may still need insurance coverage when the policy’s initial term ends (for example, though your children may now be financially independent, your savings would not generate enough income to support your surviving spouse in retirement). To guard against this possibility, be certain that the level term policy you purchase includes a clause that allows you to renew the policy (generally, such clauses allow you to renew the policy on a yearly basis up to a certain age – usually 65 to 70).
The only proper way to answer this question is to look at your specific situation. (Rules of thumb – such as, buy an amount equal to two or three times your salary – are, frankly, lousy rules to follow.) Have a life insurance “needs analysis” done by a life insurance broker or company (preferably one that only sells term life insurance).
In doing a needs analysis, a life insurance agent looks at what your beneficiaries’ income needs are, then calculates how much life insurance you would need to leave behind to generate that amount of income (after taking into account income that would be generated by other assets and/or savings that you’d leave behind). In order to get an accurate life insurance needs analysis, supply your life insurance agent with a detailed budget of your current and future income needs, as well as a detailed accounting of all the assets you currently have.
To estimate your life insurance needs, use our Insurance Needs Calculator.
The answer here is simple – increase your life insurance when your income needs rise and/or when you take on additional dependents (for example, when you have a child or have additional children). As for deciding how much additional insurance you should buy, simply ask your insurance agent to do a new needs analysis.
No. In most cases, if you leave (or lose) your job, you aren’t allowed to take the insurance with you, or, if you are, the cost of that insurance once you’ve left the company will be far too high.
Yes. In some circumstances, the only type of life insurance you will be able to qualify for is cash-value (usually because you have some type of medical condition – such as diabetes). Second, sometimes, life insurance is used as part of an overall estate plan (often, to save on the amount of estate taxes your heirs must pay). And, for the purpose of these estate plans, a cash-value life insurance policy is the only type of policy that will work.
Rick Shaffer is an attorney, financial writer and host of “The Money Show,” a call-in radio show.