Term or whole life? Universal or variable? Decisions about what kind of life insurance is right for you -- and whether you need insurance at all -- may not be keeping you up at night. But maybe you should be losing a bit of sleep, or at least be uncomfortable enough to review your coverage and your policies!
Life insurance is one of the least understood parts of financial planning. There are dozens of kinds of policies, and the legal jargon can make you cringe. It's hard to comparison shop because companies use different names for their policies, and if you ask three different agents how much insurance you need, you'll likely get three different answers.
How can you avoid short-circuiting your financial plan? Here are five common life insurance myths. If they sound familiar, you may need a life insurance adjustment, or perhaps a total makeover. Even if you're feeling pretty good about your insurance, it doesn't hurt to compare your policies and coverage with what's currently being offered.
Myth #1 -- I am alive, therefore I need life insurance.
Not everyone needs life insurance, yet people often hold on to policies because it makes them feel more secure or more responsible. The number one reason for purchasing life insurance is to protect loved ones who depend on your income -- the insurance would replace your lost earnings if something happened to you.
If you are single with no dependents, you can probably skip life insurance. If you and your partner each earn enough to be self-sufficient and you don't have children, you're better off building your nest egg than buying insurance. Also, don't spend your money on life insurance for a child unless you depend on her income.
Do you need life insurance if you're retired and you don't want to leave your spouse in the lurch? Probably not. If the two of you can live off the nest egg you've accumulated, then surely one of you can. The exception is if one of you has a pension that would disappear at death. If the survivor depends on the pension, you may need life insurance to replace the lost income.
Myth #2 -- I don't work so I don't need insurance.
Even if you're not earning a salary, you may need life insurance. A stay-at-home parent with dependent children may opt out of life insurance because there's no paycheck to replace. However, it could cost $10,000 to $30,000 per year to pay for childcare and housekeeping services in the parent's absence. Figure out how much it would cost for your family and use that number for your "salary" when calculating life insurance needs.
Myth #3 -- Odds are I won't need it, so why spend the money?
Some people just take their chances and skip life insurance completely. It's true that you are unlikely to die during your working years -- that's why life insurance is inexpensive for young, healthy people. But you're not insuring for the likely occurrence. You buy life insurance for a worst-case scenario that would have a catastrophic effect on your family. If you buy the right kind of insurance, you'll be able to provide a lot of financial security without breaking the bank. A 20-year level term policy that pays $250,000 upon death for a healthy 30-year old woman costs less than $200 a year, and the premiums are locked in for the full 20 years of the term.
So how much is enough? Although there are rules of thumb, the best way to find out is to crunch the numbers. Quicken and Insureclick both have calculators on their site for figuring out the right amount for your family (see sidebar).
Myth #4 -- If it's more expensive, it must be worth it.
For most of us, the cheaper kind -- term insurance -- is actually the better choice. Term life insurance is "pure" insurance with no investment add-on. As long as you pay your premium, you'll have coverage. You buy term insurance for the duration of time for which you'll need life insurance -- typically until the children are out of college or, if you're the sole breadwinner, until you retire. Level term insurance is the best because the premiums don't increase during the term of the policy, which can be from five to 30 years. You can always shorten the term -- just stop paying the premiums and the policy will lapse -- but it's expensive to stretch out the policy beyond the initial term.
Permanent insurance comes in lots of flavors -- whole life, universal and variable, to name a few -- and is seven to eight times more expensive than term. A permanent policy combines life insurance with an investment that builds up cash value. You can tap this money by borrowing or surrendering (cashing in) the policy.
Although it may sound appealing to get something back for all the premiums you pay, the extra administrative costs and fees whittle away at your rate of return. In general, life insurance policies make poor investments. Most of us are better off buying cheaper term insurance and investing on our own, preferably through company retirement plans or IRAs. Do your research on how much level term insurance costs and be skeptical if you're offered a high-priced alternative.
Myth #5 -- It's such a hassle to get insurance.
Thanks to the Internet, the insurance purchasing process has been streamlined. Instant online quotes for term insurance are available from dozens of highly rated companies (see sidebar). You can do the research and collect quotes on your own, then consult with a trusted agent to purchase the insurance. Or you can download application forms and work directly with the company. The agent or company will arrange to collect the medical information they will need.
If you're a do-it-yourselfer, make sure you research the company's ratings. Most quote sites have links to the ratings and explanations about how to interpret them.
Finally, if you need life insurance, don't cancel existing policies until your new insurance is in place. You don't want any gaps in your coverage.