Life insurance is not a topic most people find particularly thrilling. It’s complicated, people assume it’s expensive, and it makes us face a topic most of us would rather not think about. The thing is, none of this makes it any less important.
According to a survey by the Life Insurance and Market Research Association, the majority of people agree that life insurance brings them “peace of mind.” 80 percent of those who had a positive experience with life insurance indicated that it played a “critical role” after the death of a loved one.
So why aren’t people giving their life insurance decisions more attention, doing the proper research, and choosing the best plan they can for their circumstances?
LIMRA discovered that the main reason people claimed they didn’t buying insurance was because they believed they couldn’t afford it. Simply put, they have other financial priorities. However, the same survey found that consumers overestimated the cost of life insurance by as much as threefold. That’s a big miscalculation to let stand in the way of such an important decision.
A secondary reason provided was that the process is confusing. 12 percent of people surveyed couldn’t decide what type of life insurance to purchase, 10 percent were concerned about making the wrong decision, and 8 percent simply gave up because of a lack of knowledge about the industry.
Life insurance doesn’t have to feel like a series of confounding hurdles. Here are three things you need to know to drastically simplify the process.
1. Determining whether or not you need life insurance.
Do you currently have or plan on having dependents that you want to leave something to? If you have children, a partner, or a spouse you would like to provide for after you’re gone, it’s a good idea. If the people in your life are already taken care of, it’s perfectly reasonable to opt out of life insurance.
If you decide to support those dependents, you just need weigh your options. You can either buy insurance while you’re young (which allows you to lock in a low premium, as well as guarantee that you’ll be insurable in the first place), or wait until later (which allows you to avoid paying premiums over a longer period of time.)
2. Determining how much life insurance you need.
There are two common ways you can calculate how much insurance you need. Using the income replacement approach, start with your age and determine how many years of income you would need to replace in the event of your death. Extra considerations include projected after-tax earnings over your working years and rate of inflation. This approach generally produces a higher number than a needs-based approach.
Using the needs-based approach, make a list of the individual financial factors your death would impact, such as whether your spouse or partner would continue or start to work, the number of children you have, whether there is a mortgage you want to pay off and the cost of educating your children. This approach is much more individualized to your situation, and usually produces a smaller number than the income replacement approach.
Term insurance provides a level premium and level death benefit protection for a stated period of time. It’s the more affordable coverage option because it has significantly lower premiums and only provides protection for a defined number of years. At the end of the term, the policy has no value.
Why choose it? This type of insurance is usually appealing to younger individuals with significant financial responsibilities towards their family. They are probably responsible for the bulk of their mortgage or their dependents welfare/education (costs that the family wouldn’t be able to do without if faced with that individual’s untimely death.) By the end of the term, the need for insurance is usually reduced, if not eliminated. A lot of people choose this coverage simply because it is so much more affordable.
Permanent insurance is a little more complicated. First, it’s not constricted to a certain number of years; it covers you for life. The death benefits are comparable to term insurance, but the premiums are much higher, and they build cash savings each year (tax-deferred) until it matches the face value of the policy. This type of policy also often offers loan and withdrawal options.
Why is it so much more expensive? Because this type of policy continues until death and has a cash value, insurance companies know they will most likely be responsible for a significant payment upon death of the insured (as opposed to the term policies, where the beneficiaries may not receive any payments if the insured doesn’t die during their period of coverage.)
Why choose it? If you have no debt and considerable assets, this can be a great way to make sure your loved ones are taken care of long after you’re gone.
It’s worth noting that the “investment” feature in a permanent life policy is rarely as effective or efficient as several others, like your 401k, IRA or Roth IRA, so focus on those first.
Remember, it’s always helpful to talk with an insurance advisor who has no personal stake in your choice. Their fees are worth the amount of money and time you’ll save choosing a policy that isn’t right for you.