Making These Life Insurance Errors Can Cause Huge Problems For You And Your Heirs
A life insurance death benefit provides the ultimate safety-net for families who have not accumulated significant enough assets to “self-insure.” However, simple life insurance mistake can cause potentially huge problems down the road.
By having a life insurance policy in effect, families can remain in their own economic worlds if something terrible happens to a parent or spouse.
Life insurance proceeds can mean the difference between economic life or death for your remaining family.
Life insurance sounds simple, but figuring out what kind of life insurance to buy and how to manage the policy can be more expensive than it needs to be if you make these common mistakes.
Here are common mistakes financial planners see:
Buying Too Much Or Not Enough Life Insurance
Not everyone needs life insurance.
First, if you’re single and have no dependents, why would you buy life insurance? You probably wouldn’t… In fact, most Millennial spend more on dining out than contribute to their retirement plans or purchase life insurance, another LIMRA stat.
However, if you have young children, you’ll need some amount of life insurance.
For working parents, you can use a rule-of-thumb approach to get a rough estimate of how much life insurance you’ll need. You can use a multiple of annual salary, but that’s typically not nearly enough.
Think about creating a fund for a home purchase, paying off any college or grad school debt, and funding your kids’ college education either in full or partially.
Then you’ll need to think about how much ongoing income stay at home parents earn, and voila you get a pretty significant number!
Definitely consult a financial advisor to help you go through these numbers, or you can use our calculator here.
Make Sure To Plan For Childcare
Some couples think that a stay-at-home spouse doesn’t need life insurance.
Wrong! If you take a look at the graphic below, and you’ll realize that the cost of daycare represents a HUGE family expense.
In California alone, the average price for an infant in a “center setting” like Montessori costs over $16,000 annually.
Home care is about a third less.
If you don’t have adequate life insurance coverage on the non-working parent, you’ll need to have a chunk of money to invest in replacing this cost at his death. It’s simply a good idea to think about childcare in your planning.
Many couples fail to explore this problem in their life insurance planning adequately.
Don’t Buy The Wrong Kind Of Life Insurance Policy
Do you need term insurance or permanent insurance?
Term life insurance is simple, cheap and covers you for a specified duration like 10, 20 or 30 years. For example, a healthy 30-year old male can buy a $1,000,000 20-year term life plan for less than $50 per month! If you wait too long to buy life insurance, it can get expensive.
It only pays a benefit if the policyholder dies during the term of the policy.
Once the level payment period expires, you can renew the plan on an annual basis but those “renewal premiums” can get huge in a hurry.
Most folks either drop the policy at that point or try to apply for a new policy if they are in good health.
Permanent Life Insurance
Permanent insurance comes in a variety of flavors-Whole Life, Universal Life, Indexed Universal Life, Adjustable Life, etc.
These policies are designed for the long haul your entire life. They are typically used in conjunction with a long term estate plan.
Yes, they definitely cost more initially, but the premiums can remain the same forever. As long as you pay the premium, the insurance company is obligated to pay the death benefit.
Permanent life insurance cash value, which grows slowly over many years.
Typically people should not “invest” in a life insurance policy because the cash component grows so slowly and they would have been far better off buying term life insurance and investing the difference. You can do much better for your financial plan by keeping life insurance separate from your investments.
A critical feature for permanent life insurance is the fact that you can borrow against the cash value at very favorable interest rates or terminate the policy and take the cash.
Be Wary Of Life Insurance Fees
Any form of permanent insurance is more complicated and expensive than term life. It also can pay the highest commission for insurance brokers and agents.
Remember, fees are an essential aspect of wealth accumulation-the higher the charges on a financial product, the higher the return needs to be to offset the bite they take out of your assets.
Term life is usually the best choice for most young families as it provides the biggest bang for your insurance dollar.
In my practice, I always recommend that families start off with term insurance and get the exact right amount they need. You can play with our life insurance calculator here.
You Can Always Convert Your Term Life Insurance Policy
Some people do end up buying permanent policies over a long period, and it can make good sense, especially if you develop a chronic illness that would preclude you from getting a new term life policy at the end of the term period.
You can always switch into a permanent plan without proving to the insurance company that you’re in good health.
This is called the “conversion option,” and all modern term policies have this feature. Permanent life insurance can be used as an estate tax planning tool for those who have large estates over approximately $23 million per couple(indexed for inflation).
These policies are typically owned by a special irrevocable life insurance trusts or ILIT which keeps the policy out of the taxable estate.
Don’t Procrastinate When Searching For Life Insurance
Why Buy Life Insurance Now?
It’s way more natural to blow off buying life insurance than it is to think about how your premature death will affect those you care about.
Strike while the iron is hot!
By procrastinating and not getting the foundational life insurance you n
eed, you’re jeopardizing the financial well-being of your family. If you’re worried about the cost?
It’s cheaper than you think.
Most young consumers overestimate the cost of term life insurance.
A male age 35 in good health can get a 20-year term life policy for under $50 per month.
Don’t Smoke If You Want Cheap Life Insurance
If you smoke, the cost can almost double-so quit!
Women pay even less- like over 50% less! Compare quotes from a few companies to find the best rates.
Group Insurance Is Almost Never Cheaper Than Individual Term Life Policies
Relying on group life insurance through work is often not enough for those who have a family depending on their income.
Many employers include a small amount of group life insurance in their employee benefit plans.
Typically the amount is a multiple of salary which is capped at a certain level.
Anything the employer gives the employee above $50,000 is taxed as income on the W-2 form at the end of the year.
As you age, this can turn out to be a large number.
Another major disadvantage is that group term life insurance is not portable.
This means that if you leave your job and go somewhere else, you might not have the same level of life insurance protection at the new employer.
Consider buying your own personal supplemental life insurance that can go wherever you go.
It’s usually much cheaper than group insurance, too.
This is because you need to prove you’re in good health to get the policy.
Group insurance is not “underwritten,” so it’s based on the lowest common denominator of health.
The actuaries assume that the company is full of old, sick people and they price the group with that in mind.
We’re Here To Help You
As always, if you have any questions at all about your personal financial situation and want to discuss life insurance, we’d be glad to speak on the phone or via email. We want to help you and there’s never any sales pressure. Please call us at 650-969-5844