What to Consider When Buying Life Insurance
Buying life insurance is a lot like wearing a seat belt. While you don’t hope to use it for its intended purpose, you (and your family) will be happy and relieved it’s there in case you do. This is especially true if you have a lot to protect including a spouse/partner, children, or major liabilities like a mortgage or other debt.
It’s hard enough navigating past pushy insurance salespeople let alone determining how much and what type of policy to buy. Consider the following before embarking on your search for life insurance.
Coverage Amount
Figuring out how much life insurance to buy is as objective as your favorite color. There’s no one-size-fits-all strategy, and your personal circumstances, budget, and preferences can play a huge role. When determining how much coverage you and your family need, the “field goal” method may help you with your decision. This encourages you to think through the appropriate range your death benefit should fall into. The death benefit is the amount of money (usually tax free) that your beneficiary/beneficiaries will receive when you die. The larger the death benefit, the more expensive the policy.
One goal post in the field goal method represents the minimum amount of life insurance coverage you and your family need. This amount is different for everyone depending on your level of cash reserves, investments, debt, etc., but often includes the cost of a funeral and a cushion of money your family may benefit from after you die. The other goal post represents that maximum coverage that your family would need. This often includes funeral expenses, covering major debts such as a home mortgage and car loans, and may include an income-replacement strategy in which beneficiaries can draw upon a pool of assets to live a comfortable life after you pass, among other things. This amount will also vary widely for different people. Once you set the goal posts of the minimum and maximum coverage feasible in your situation, you can then kick the field goal and determine the level of coverage within that range that fits your budget and best suits your situation.
Types of Policies
There are two primary types of life insurance policies out there: permanent and term. The main differences include how long the policy is in force, the premium (cost) amount, and a cash or investment component.
Permanent
Permanent policies, just like they sound, are designed to be paid into and last throughout your entire lifetime. When funded properly, permanent life insurance policies will make a death benefit payment. Common permanent policies include Whole Life, Universal Life, and Variable Universal Life policies. Unsurprisingly, permanent insurance is more expensive relative to term policies. It’s important to keep in mind that most permanent policies have a cash or investment account associated with them, depending on which type you buy. When you make your payment (premium) towards the policy, it is divided to cover the cost of insurance and to also partly fund your cash or investment account. You usually have the ability to take a loan or a partial withdrawal from the cash or investment account or use it to later fund the cost of insurance. A “paid-up” policy refers to a permanent insurance policy that has enough saved into it in order to fund it for the insured’s lifetime.
Permanent policies are great for people who think they will always need life insurance coverage. It may also suit those who don’t have outside investment accounts, as they can be a good way to save for the future when used properly. Those exploring permanent policies need to ensure that their cash flow allows for ongoing payments towards their policy. There’s nothing worse for insurance owners than owning and paying into a permanent life insurance policy and then later allowing it to lapse. In that case, you would have been better off just opting for a term policy as a cheaper alternative!
Term
Term policies offer temporary life insurance coverage for a set period of time or “term”. Once the term passes, the insured loses coverage, and is no longer responsible for making premium payments towards the policy. Term policies are often referred to by the length of time in which they are “in force” or active. A term policy in force for 20 years is typically called a “20-year term” policy. The cost of term policies is typically much lower than permanent policies, as the premium payment simply covers the cost of insurance, and there is no cash or investment account associated with the policy.
Term policies work well for people with a temporary need for life insurance. Most commonly, these are purchased by families with young children. If one parent were to pass away, for example, the family may be left in dire straights due to a loss of income and often high living expenses compared to later in life (consider mortgage payments, travel, and kids’ education during these years). They also suit people who may eventually have a sizable savings or investment account after years of saving. After a certain point in time, these people could have enough set aside so if they do die prematurely, their beneficiaries would inherit their savings or investment accounts which makes ongoing life insurance coverage less necessary. People who buy term policies may be better off paying a much lower premium than with permanent policies while having the ability to save and invest the extra amount they would have spent on a permanent policy. Keep in mind that insurance agents make a MUCH larger commission on selling you permanent policies, so don’t be surprised if they push you in that direction if you work with one to explore coverage.
How to Buy
So, you figured out how much and what type of life insurance will meet your needs. Where do you look to actually buy a policy? A great place to start is within your employer group benefits. If you work full-time, you may have life insurance coverage on top of your health and retirement benefits through your employer. Group coverage might be paid for by your organization, and if it’s not, you may get the best dollar-for-dollar coverage, and the payment can be easily deducted from your paycheck. The other great thing about group insurance coverage is it typically does not require underwriting. This is when the insurance company does a medical assessment and gathers records to approve or deny you for coverage. Insurance companies know they are betting against you, and they don’t necessarily want to insure people with a greater probability of dying. The underwriting process can be a long and strenuous process often lasting several months, so opting for group coverage may enable you to avoid it altogether. This is especially beneficial if you are in poor health, as underwriting may restrict or limit life insurance coverage.
The one big downside to most employer life insurance coverage is its “mobility,” or lack thereof. Mobility refers to the ability to keep the policy if you leave your job. In other words, if you leave your employer for a new job or retire altogether, it’s very unlikely that you will keep your life insurance coverage. When this occurs, and you and your family need coverage, you will be required to either opt into your new employer’s coverage (if they offer it) or buy individual coverage and likely go through underwriting.
In addition to group coverage, you may also need to explore individual coverage to reach the optimal level of coverage that your family needs. Finding an appropriate policy doesn’t have to be an arduous process. We all dread the pushy insurance sales people. To make matters worse, the “industry” isn’t exactly on your side. Like most salespeople, insurance agents often earn a commission based on the type of policy you buy and your premium (the cost of insurance), which is largely driven by your death benefit amount. In most cases, the bigger the policy, the more money the agent will make, so they are incentivized to sell you a policy that may not be in your best interest. As mentioned before, they also earn a much higher commission on selling permanent policies over term policies. Insurance agents could provide value in explaining the application and underwriting process, but keep in mind, you can also explore and purchase policies online and largely avoid paying a commission. If you work with a fee-only planner (like me), it’s likely they do not sell insurance policies, but instead can help you find cheap coverage online or refer you to an insurance professional they know and trust.
The reality is researching and purchasing life insurance isn’t exactly a trip to Disneyland, and the underwriting process is not for the faint of heart. Maintaining appropriate coverage, however, is super important to protect you family or loved ones. If you work with a financial advisor through comprehensive financial planning, make sure have a conversation about life insurance needs and how different policy types and coverage amounts will have an impact on your plan.
Are you ready to work with a fee-only financial planner to learn how much and what type of coverage you need? Reach out to me at Ben@coveplanning.com or schedule a free consultation call.
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Ben Smith is a fee-only financial advisor and CERTIFIED FINANCIAL PLANNER™ (CFP®) Professional with offices in Milwaukee, WI, Evanston, IL and Minneapolis, MN, serving clients virtually across the country. Cove Financial Planning provides comprehensive financial planning and investment management services to individuals and families, regardless of location, with a focus on Socially Responsible Investing (SRI).
Ben acts as a fiduciary for his clients. He does not sell financial products or take commissions. Simply put, he sits on your side of the table and always works in your best interest. Learn more how we can help you Do Well While Doing Good!
Disclaimer: This article is provided for general information and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. I encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Ben Smith, and all rights are reserved. Read the full Disclaimer.