Purchasing life insurance is a big decision. It helps compensate spouses and/or dependent children after you pass. Having sufficient life insurance will assist your remaining family members maintain a standard of living, especially if you are the primary earner. At the very least, it should take care of your funeral costs. There’s no need to have your grieving loved ones stressed about that extra expense too.
Choosing the right life insurance policy for you and your family’s needs is therefore very important. Yet, a 2018 study by Foresters Financial found that only 59% of Americans have a life insurance policy. Among those, nearly half were considered under-insured. That means they are carrying a policy that will not adequately cover their loved ones if they die. You don’t want that. Here’s what you should consider when shopping for life insurance.
Whole Life vs. Term Life
Essentially there are two types of life insurance policies – whole life and term life. Here’s a breakdown of the two policies and how each one works.
Often referred to within the industry as “permanent life insurance,” whole life provides coverage for your entire lifetime. It is guaranteed to pay out when you die, no matter how long that takes. Most whole life policies require you to pay monthly or annual premiums. These are typically higher than those charged for term life insurance. However, the premiums charged for whole life insurance are usually fixed regardless of your health as you age.
Some whole life policies allow you to pay premiums for a certain time period and never pay again. For example, the payments might cease after 25 or 30 years. The benefit of a whole life insurance policy is that it never has to be renewed. It is guaranteed to pay out once you inevitably pass.
Term life is coverage that is only provided for a set period of time. Usually, term life policies run for around 10-to-20 years. However, policies do exist for longer terms, depending on your age and overall health. One big advantage of term life is that the costs remain the same throughout the coverage period. The only time the cost changes is if the policy is renewed.
Factors that may lead to an increase in the monthly premium at renewal include changes to your health, job situation, and/or lifestyle. Depending on your health at the time of renewal, the policy can be denied or altered by an insurance company. For example, if you develop diabetes or other common health issues as you get older, you may only be offered shorter terms (5 or 10 years), or more expensive monthly premiums.
The older you get, the more expensive term life insurance policies become. It’s designed for people who want a more affordable policy that provides temporary protection against unexpected death. Term life typically doesn’t come with all the bells and whistles of whole life insurance. As the name states, it is only valid for a limited period. It does, however, provide replacement income for your dependents in case of death. The payments to beneficiaries are usually tax-free.
Which Policy Is Best?
The two main factors to consider when deciding whether to purchase whole or term life insurance are your income and overall health. Term life insurance is a good option for younger people. You probably want some temporary and more affordable protection as you raise children and pay down your mortgage. If something happens to you, at least you know your children or partner won’t be financial ruin. Many new parents get a term life policy for 20 or 25 years. That ensures the children are covered until they are grown up and taking care of themselves.
Term life can also help you put money towards other financial priorities, while still providing protection. Since it’s a cheaper option, it has less strain on your ability to save (or to simply budget). However, the longer you wait to buy any kind of life insurance, the more expensive it gets. Follow this wise advice:
“The absolute best time to buy life insurance was five years ago. The second-best time is today.”
A term life policy for a 25-year-old will be dirt cheap. The insurance company is banking on you outliving your policy entirely. Hopefully, you do! However, trying to buy a 20-year term life policy as you approach 40, and things get harder. The insurance company will factor in your age, health, family medical history, and a bunch of general statistics about your gender, race, location, etc, in order to reduce their risk of losing money on your policy.
The Costlier (But More Protective) Option
Whole life insurance is beneficial to people who want a guaranteed payout when they pass. Because whole life is not renewed after purchased, any health issues that arise are not a factor with the policy. Whole life cannot be denied or canceled should your health worsen as you age. On the flip side of that benefit, though, is the fact that you may not be able to get whole life insurance at all if you wait until after a big health scare. So get it before you need it.
Whole life insurance can be beneficial for estate planning, since it’s a sure thing. It can provide peace of mind to your family that they will have financial security after your death. However, some financial experts will tell that using whole life insurance as an estate planning tool is a mistake. The money you spend on premiums could probably be better used invested. The only real advantage, from an estate planning perspective, is if you pass away much earlier than expected. In that case, your investments probably wouldn’t have had the time to grow and match your insurance payout.
Whole life insurance policies tend to be substantially more expensive than term life policies. Part of that extra cost is due to whole life policies having an investment component. However, if you have the available funds, it might still be worth it to you. Like most financial situations, there are pros and cons though.
As previously mentioned, the one big benefit of whole life insurance is if you pass away early. Skipping a couple decades of premiums in exchange for a big insurance payout is a nice win for your heirs. However, you should also consider the alternative option. That is, buy a term policy that will cover you for long enough — typically until your kids are old enough to be financially independent. Use the savings to invest more of your money. Those investments, when done right, could more than make up the difference in your estate value.
How Much Do You Need?
Knowing the proper amount of life insurance you need is important. It is, in fact, the key question. How much you need to be insured for depends on a lot of factors. Your age, the age of your children, your annual income, your living situation, and the lifestyle of your family are all huge factors. Remember that life insurance is meant to replace your income if you pass away.
Most insurance companies say a reasonable amount of life insurance is six to ten times the amount of your current annual salary. Another way to calculate is to multiply your annual salary by the number of years you have left until retirement. In the end, you will want to ensure that the payout helps your spouse and children retain the lifestyle they had when you were alive and providing for them financially.
You’ll need to consider various factors. For example, would your insurance need to cover a university degree for one or more children? What about paying off the rest of your mortgage so that your spouse isn’t forced out of the family home? For that matter, does your spouse depend on your income or are they financially secure on their own? What about funeral costs? How much coverage you need depends on your specific situation. As a rule of thumb, it’s always better to be over-insured than under-insured. If you can afford it, that is.
There are some additional things to be aware of when shopping for life insurance. You will likely need to undergo a physical examination (including a blood and/or urine test) before the insurance company will issue a policy. Lifestyle factors such as alcohol or drug consumption and whether you smoke are factored into your policy. These things will impact the premiums you pay.
Keep in mind that life insurance is meant as a risk mitigation tool and not as an investment. You should not treat life insurance as an investment vehicle (which is one of the biggest knocks on whole life insurance). There are better ways to invest your money – from funding a 401k plan to aggressively paying down your mortgage. Although there are some types of life insurance plans that allow you receive payouts down the road in exchange for reduced coverage, these are almost always a bad idea. Remember that the insurance company’s main goal is to not lose money on your policy.
Lastly, canceling a life insurance policy prematurely can be complicated and expensive. Some insurance companies require you to pay the entire remaining premiums should you want to cancel a term life policy early. There’s almost no good reason to cancel a life insurance policy of any kind, since acquiring new coverage will probably be even more expensive as you age. Deciding to go completely uninsured is also a bad idea. If you’re struggling to pay your premiums, try saving money in other areas instead. Lastly, you should never cancel one life insurance policy until a new one is in place.
The Last Word
Life insurance is a valuable tool meant to provide peace of mind and financial coverage for your family when you’re gone. Buying a life insurance policy should not be taken lightly. Be sure to do your homework and shop around with various companies. Take the time to make the needed calculations. Consider your specific situation, and determine whether whole or term life insurance is best for you.
In the end, you’ll want an affordable policy that provides the right amount of compensation in the event of your untimely death. The age of your children, your annual salary, current health, current financial situation, and lifestyle should all be given consideration when choosing a life insurance policy.
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