Buying life insurance isn’t on your list of Top Fun Activities. Nevertheless, it’s one of the most important activities you can complete on behalf of your loved ones.
But because the concept is distasteful, and the products are so confusing, many people make common mistakes. We describe seven of them here – to help you avoid them:
1. Not Buying Enough Coverage
Does $500,000 sound like a lot of life insurance? Well, try this little trick: Cut in Half and Drop a Zero. This is a quick, easy way to help you determine whether you’re buying enough coverage.
Here’s an example of an estimate for a $500,000 policy. First, cut it in half: The result is $250,000. Then, drop a zero: You get $25,000. That’s how much money your heirs might be able to generate in annual withdrawals from the policy’s death benefit. If $2,083 per month doesn’t sound like enough to provide for your family, then $500,000 isn’t enough insurance.
Ask a licensed, independent, fee-based financial advisor for help in determining how much insurance you need.
2. Buying the Wrong Type of Policy
Your goal is to get the insurance you need at the lowest price. Generally, the cheapest annual cost is provided by a type of life insurance called a “term” policy, which lets you lock in the price for a specific term – a period as long as 30 years. Term policies are best for most people, because you likely won’t need the policy after the term is up – say, after the kids are grown and you’ve retired.
But that’s not always true. In many cases, you’ll need to maintain coverage for your entire life (as part of an estate plan, for example) – and term insurance becomes exorbitantly expensive if held after its term limit is reached. If you need insurance forever, you should consider whole-life insurance which, as its name implies, provides coverage for your entire life. You may pay more for these in the early years than you would for term insurance, but they generally become more economical over the life of the policy.
You might also consider “universal life” and other types of insurance, which attempt to merge the features of term and whole. And if you’re like many people, you may have more than one need for insurance and therefore, you might need more than one policy – some providing temporary coverage like term insurance and others offering permanent protection. Edelman Financial Engines can help you determine what type, or combination of types, of insurance is best for you.
3. Not Comparing Rates
Life insurance prices are based on probabilities of death, and every insurance company uses different data to assess your risk. All insurers charge more if you smoke, but many have different views regarding other habits or medical conditions. Some insurers, for example, won’t insure people who skydive, while others merely charge more. So, it’s important that you shop around when buying life insurance – just as you would for any major purchase.
Some advisors who hold insurance licenses are employees of a single insurance company and represent that company; others represent many. Those who represent insurance companies are called agents and those who represent you and work with several companies are called brokers. So, if you want to get quotes from many insurance companies, you can contact several agents or one broker.
4. Automatically Buying the Cheapest Policy
This mistake is the flip of the prior one. When people do shop for rates from several insurers, they often select the company offering the lowest price. But that can be costly if the insurer goes out of business or is otherwise unable to pay the benefit you’re paying for.
This is why it’s important to examine the insurer’s ratings and its “claims paying ability.” Your insurance agent or broker can give you this information.
5. Thinking Illustrations Are Fact
If you’re considering a whole or universal life policy, your insurance agent will give you a document, called an “illustration,” that shows you the annual cost of the policy and, supposedly, its future cash value. Be aware that the numbers you see on the illustration are merely projections. They are not guaranteed (unless you see that word printed there!) and the reality could prove to be very different from what is illustrated.
You need to disregard everything agents verbally say and give little credence to any illustrations they give you – none of that is legally binding. The only information you can rely on is the insurance contract itself; that’s the actual legal agreement between you and the insurance company.
6. Viewing the Purchase of Life Insurance as a One-Time Activity
As with every aspect of financial planning, evaluating your life insurance needs is a process, not a product. And the process is ongoing, because your life continues to progress.
Over time, family members are born and pass away. Your marital status changes. So does your health, income and occupation – even your attitude about heirs. So, a policy you bought 20 years ago might have been perfect at the time, but its death benefit may not be what you need today.
That’s why you should review your insurance needs every few years, and anytime you’ve experienced a major change in your life, so your insurance-licensed financial advisor can help you decide whether the coverage you currently have is the coverage that’s still right for you.
7. Canceling a Policy Before You Obtain the New One
People are living longer now* – which is one reason why the cost of term life insurance is cheaper than ever. Thus, it might be worthwhile for you to replace a current policy with a new one. But if you’re going to replace a policy, don’t cancel the old one until the new one is in force. You don’t want to be without coverage – even for a single day.
*Source: The World Bank Group. Life expectancy at birth, total (years). https://data.worldbank.org/indicator/SP.DYN.LE00.IN
Neither Financial Engines Advisors L.L.C. nor its affiliates offer tax or legal advice. Interested parties are strongly encouraged to seek advice from qualified tax and/or legal experts regarding the best options for your particular circumstances.
Neither Edelman Financial Engines nor any of its affiliates, or their advisors, sell insurance products. EFE’s affiliates may receive insurance-related compensation for the referral of insurance opportunities to third parties if individuals elect to purchase insurance through those third parties. AM1289472.