In its purest form, life insurance is one of the best deals for consumers. You pay a company a small amount every year to make sure that your dependents are protected in the event of an untimely death.
Unfortunately, not enough Americans are choosing to purchase an adequate amount of life insurance coverage. According to a recent study by two insurance industry trade groups, one in three households would have immediate trouble paying living expenses if the primary wage earner died.
Part of the problem is that people just don’t like thinking about untimely death. But another factor is that the insurance industry sometimes strays from the simple and effective solution, leaving would-be policy owners confused and, more importantly, uninsured. The study also found that 40 percent have not bought life insurance — or more of it — because they are unsure of how much coverage they need or what type to buy, or because it was too expensive. Let’s break down these issues.
HOW MUCH COVERAGE SHOULD YOU PURCHASE? You need enough to do these things: cover living expenses for survivors; fund future educational expenses; in some circumstances to provide for the future retirement needs of the surviving spouse. Years ago, many used the “eight to 10 times annual income” rule of thumb to determine the proper insurance amount. Now you can determine your specific needs with online calculators. If you are using insurance to fund a future estate tax liability, you should use an amount recommended by your estate attorney.
WHAT TYPE OF LIFE INSURANCE IS MOST APPROPRIATE? There are two basic types: term and permanent. Term is best for those who have a specific insurance need for a defined period of time, such as a young couple with kids who have not yet saved a sufficient nest egg to support their survivors in the event of premature death. During the stated term, if the insured dies, the insurance company pays the face amount of the policy to the named beneficiary. Premiums for term policies are often reasonable for those in good health up to about age 50. After 50, premiums start to get progressively more expensive.
Permanent life insurance is a more expensive option because it combines the death benefit with a savings or investment component, and it remains in force until you die. There are three types of permanent: traditional whole life, universal and variable universal. Whole-life policy owners rely on insurance company dividends as the source of accumulation inside the policy. Universal and variable universal life holders invest by using sub-accounts, which are akin to mutual funds, inside the policy.
Permanent life insurance earnings grow on a tax-deferred basis, but you don’t have to die to get your money because these policies allow you to borrow against your cash value. The downside is the hefty price tag. High fees and commissions can eat into those beautiful projected returns and eat up as much as three percentage points from the annual return. Upfront commissions are typically 100 percent of the first year’s premium.
If you are weighing term vs. permanent, you may want to consult a fee-only financial adviser, who does not sell insurance but can evaluate your needs, determine the right type of coverage and refer you to a reputable life insurance agent.