Life Insurance is a subject that has all of the elements of a
perfect storm for poor decision-making.
It’s complicated.
It’s boring.
It can be expensive.
It’s wrought with potential conflicts of interest.
It deals with a subject we don’t want to confront.
Many people don’t purchase enough life insurance to cover
their needs. Of those that do, many end up making critical mistakes and buying
insurance that is not optimal.
According to the Life Insurance and Market Research
Association, more than 30 million Generation X and Y households surveyed
reported that they needed more life insurance in 2012. One-third of wives own
no life insurance at all.
These basics might help you find your way through the
insurance thicket:
1. Determine whether or not you need life insurance. Not
everyone needs life insurance. If you are young and without dependents, you may
not need life insurance. If you plan on having
Dependents, it can be a good idea to buy insurance when you
are young. By doing so, you guarantee your insurability (as long as you
continue to pay the premiums).
2. Determine how much life insurance you need. There are two
ways you can calculate how much insurance you need:
Income replacement: This approach considers your age and
earnings. It generally produces a higher number than a needs-based approach.
You start with your age and determine how many years of income you would need
to replace in the event of your death. For example, if you are 40 years old,
you might decide to buy insurance that would pay 15 or 20 times your yearly
income. Some calculations using this approach take into consideration your
projected after-tax earnings over your working years, factor in inflation and
discount the results to present value. The basic problem with this approach is
that it’s not very individualized.
My preference is for the needs-based approach, but it will
take more time and reflection to get it right.
Mint.com has a useful “life insurance plan
wizard" that will help you calculate the amount of insurance you need.
3. Determine the type of insurance you need. The two basic
types of insurance are term and cash-value insurance (which is also referred to
as permanent insurance).
Term insurance has no investment component. You just decide
how much coverage you need and the period of time you want that coverage to
remain in effect. You can obtain term insurance that has a level premium over
the term of the policy. Term insurance has lower premiums than cash-value
insurance. Many financial planners recommend buying term insurance and
investing the difference between a term-insurance premium and a cash-value
premium.
If your annual premium for insurance will be $10,000 a year
or more, consider retaining a fee-only insurance advisor, one who doesn't have
any financial stake in your decision. These advisors can save you far more than
their fee, and you can feel more assured their advice is objective and in your
best interest.
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