When I worked for a large financial services firm, one of my colleagues used to joke about what a tough business it was selling products you couldn’t use unless you were sick, disabled, or dead. No wonder people would run when they saw us coming! While it is true that life insurance is one of those products that are sold and not bought, if you have people depending on you for support, you probably need life insurance.
The concept seems simple enough: you pay a premium, and when you die, the life insurance company pays your beneficiary. But one of the first things I learned in the insurance business was that life insurance products are much more complex than that. Once you decide you need it, there are plenty of other decisions to sort out—how much insurance should you have, what kind should you buy, and where to buy it, for example.
1. Decide how much coverage you need
Here you want to use the Goldilocks approach to be sure your coverage is just right. You don’t want to have too little to protect your family, yet no one should be worth more dead than alive! The purpose of life insurance is to replace your economic value, not to enrich your heirs. There are many calculators online you can use, but the basic idea is to have a death benefit that will be enough to replace the income of the insured. You’ll want to take into account whether or not you want to provide for lump sum expense such as college for the kids, paying off debt, or funding a leave of absence from work for your spouse to care for your children or recover emotionally. Also, remember that not only regular living expenses need to be covered, but the opportunity for that person to contribute to the couple’s retirement fund is lost as well.
2. Choose the type
The kind of insurance you need, of course, depends on… well, your needs. For generous coverage at an affordable price, you can’t beat term insurance. And for young families with children especially, generous coverage is a necessity, and money is usually tight.
Term insurance covers you for a term, like renting, and when your policy expires or you stop paying premiums, you lose your coverage. It’s not unlike auto or homeowners insurance in that respect. Term insurance comes in different varieties: level premium, where the premium is fixed for a specified term such as 10, 15, or 20 years, or renewable term, where the premium increases each year or sometimes every five years. Many term insurance policies can be converted to a permanent policy later, within limitations.
On the other end of the spectrum is whole life insurance, or the Cadillac of insurance policies. Whole life policies are designed to cover you for your whole life, accumulate a cash value, and pay dividends that can be used to purchase additional insurance, reduce premium, or accumulate with interest. The premiums are fixed, like with term insurance. Sometimes these policies are sold with the assumption that the cash value will grow enough so that they will become “paid up” at a future point in time and no more premiums will be necessary. That does not always work out, unless it is contractually guaranteed. The cash value of a policy is typically available to you to borrow with a phone call or filling out a form—no credit checks or application process, and no payments required. Like any loan, a loan against the cash value will carry interest, the rate determined by your policy contract. While you won’t have a regular payment schedule, if you do not pay the interest due each year, the policy will borrow against itself to pay the interest. If the insured dies with the loan still outstanding, the loan will simply be subtracted from the death benefit. Of course, these benefits come with much higher premiums too.
Variable life insurance is similar to whole life in that it is permanent, but instead of the cash value and death benefit growing through dividends, you have the opportunity to invest the cash value in the stock market through “sub accounts,” which are similar to mutual funds. While the goal is to grow the policy faster through investing in the market, there is also the risk that the policy will not perform as well as expected, and more premiums may be required to keep the policy in force. Variable universal life is basically a variable policy with the flexible premium feature of a universal life policy.
Universal life insurance is also a permanent policy, but the premiums are flexible, meaning you can choose to pay a lower or higher premium than the policy calls for. The cash value is not invested in the stock market, but earns interest, with a rate that may fluctuate, but not below a minimum. These policies can be illustrated many different ways, and can be designed to be guaranteed to “run” to any specific age, or for your entire life. There is a variation called universal life with a secondary guarantee, and these policies are sold as an alternative to term insurance. The premiums are lower than a traditional universal life policy because they accumulate little or no cash value, but provide a long term death benefit.
3. Find an agent on your side.
Life insurance is sold by insurance agents: some strictly sell insurance, while others are financial advisors with an insurance license. Because premiums are the same all over, the important thing is to work with an agent who will sell you the product that is right for you. Life insurance is a tough sell, so the first year commission on a policy can range anywhere from 45% to over 100% of the first year’s premium (plus renewal commissions on permanent policies). In recent years the industry has developed low fee policies too, in order to better serve the clients of fee only advisors who do not sell products. Working with an agent who represents multiple carriers is beneficial, as insurance companies rate health histories differently; it pays to shop around. Of course you will want to use a highly rated insurance carrier, and good service from the agent is important. But the most important thing is to get the coverage you need now—we’d all like to wait to buy a policy until the day before we need it—but you just never know.