Welcome to the third entry in my “Ultimate Guide” series here on The Simple Dollar. If you want to hop back to the first two, here are some quick links:
Ultimate Guide to Choosing an Internet Service Provider
Ultimate Guide to Amazon Discounts
Today, we’re taking a deeper look at life insurance policies. Life insurance is one of those sticky things that feel like a needless expense until you need it… and then you really need it.
For me, life insurance really didn’t become an issue until my wife and I started having children and we started seriously evaluating their future. What would their life be like if I suddenly passed away? Would Sarah be able to adequately provide for them as they grew older? What if both of us passed away suddenly?
We did a lot of research, shopped around, and eventually wound up with policies that protect each other and, more importantly, protect our children. This guide will walk you through many of the key facts and concepts we learned during that journey.
Life Insurance Types – and Why Term Is the Best for Most People
There are a lot of different kinds of life insurance policies floating around out there with different names and attributes associated with them. Universal, whole life, cash value… you’re going to hear these terms bandied about by life insurance salesmen.
Here’s the truth of the matter: the vast majority of them amount to an ordinary term life insurance policy bundled with something else, usually an investment of questionable value.
So, let’s back up. A term life insurance policy is one that covers a certain amount of years – say, thirty, for example. Once that agreement is signed, you pay the company issuing the policy a small amount – the premium – on a regular basis. If you were to die before the end of that term and your premiums are paid up, the beneficiary of your policy receives the value of your policy. If the term ends and you’re still alive, both you and the company walk away.
So, what makes this better than other policies? Cost. A term policy is going to be far and away less expensive for the amount of insurance you get as compared to other policies.
Other types of policies are largely term policies with special additions written in… but those special additions are costly. Some policies add in an investment aspect, where the investment returns poorly for the first twenty or thirty years (some of them do well after a significant period of time, but that first period isn’t good). Others pledge to cover your whole life, but they end up being very expensive, too.
The best method of all is to simply buy a term policy and pair it with some savings of your own.
What happens if you reach the end of the policy? If you’ve been saving, you shouldn’t need a big insurance policy at that point. Big insurance policies make sense when you have several dependents, but when the term of the policy runs out, you shouldn’t have many dependents at all, so you don’t need that big influx of cash.
Some people may not be eligible for some policies. Life insurance is a product sold by a company that wishes to minimize their risk, and if you have significant risk factors that indicate a higher chance of the company having to pay out on your policy, you may have to pay higher premiums or not have insurance at all. On the other hand, don’t assume that you’re uninsurable, either. These companies know what they’re doing and can sometimes offer policies to people who might otherwise seem risky.
Even in these situations, the processes below of shopping around for policies can still point you to the best possible deal for your situation, even if the rates are high.
“Peace of Mind” Product
A key thing to remember is that life insurance is a “peace of mind” product. It’s not something you are ever going to have to tap into. If you’re purchasing the policy for peace of mind, it should completely cover the things that you’re worried about.
That’s an important factor to keep in mind when you’re determining the specifics of the policy you need.
How Long Should My Term Be?
Should I get a ten year policy? A twenty year? A thirty year? It’s not an easy question.
Generally, the longer the term of the policy, the higher the premiums are going to be. That makes sense if you think about it – the longer the term of the policy, the more likely the insurance company is going to have to pay out.
The real question you need to ask yourself is why do you need this policy? What situation are you protecting yourself against?
Many people buy term life insurance policies to make sure that their children are financially protected through their childhood. Others might buy a policy simply to protect their spouse until retirement.
You should sit down and ask yourself at what point that reason is no longer relevant. When will your kids grow up and move out? When will you hit retirement age?
Those types of questions will point you straight at the policy term you should be looking for. Need one for the next fifteen to eighteen years? Get a twenty year policy. Need one for twenty five years? Get a thirty year policy. Are things going to be fine in eight years or so? Get a ten year policy.
How Much Insurance Should I Get?
During the process of figuring out the term of the policy, you’re also going to get a sense of what exactly you’re insuring against. You’ll know how long you need that policy for and what kinds of expenses you’re hoping to cover.
The next question to ask yourself is how much money that adds up to. My recommendation is that, if you know how long you’re going to need protection, you should have enough insurance to replace your take-home income for that entire period. If you have a baby at home and you want to make sure they’re good through high school, you should calculate how much your take-home pay would be through that whole period, for example.
It’s important to remember that this is just a handy “back of the envelope” calculation. You should also take into account your full financial picture before diving in, because a family in a lot of debt would need more insurance than a family in a strong financial position.
The best route is to contact a fee-only financial advisor, one that does not have a vested interest in selling you a product, and have them go over your finances with you and help you figure out the right amount for your situation. Don’t use a commission-based financial advisor for this, as they’ll be primarily interested in selling you a policy.
A final piece to chew on: the younger you are, the cheaper your premiums will be, so if you’re a new parent at age 25 and are buying insurance to protect your child, the rates will be pretty low, even if the total amount is high, because your risk of dying before 50 or 55 is really low.
So, you’ve decided on a term policy and you have a good idea of what kind of term you want. What now?
The first step is to shop around for the best price. The easiest way to do that is to use a life insurance broker such as AccuQuote, FindMyInsurance, or LifeInsure. All of these services make it easy to compare rates among different insurers once you’ve filled out some basic questions about yourself.
However, you don’t want to strictly go for the lowest rate. You are going to want to use a stable insurance provider that’s going to still be in business in fifteen years.
The easiest way to check out the stability of an insurance company is to check out their financial strength rating at an independent rating agency. For example, you can stop at TheStreet and look for the financial strength rating of each insurer you’re considering. You’re going to want to make sure that any insurer you’re seriously considering has a strong rating.
Another step you can take to minimize your risk is to “insure your insurance.”
Each state has a guaranty association that life insurance providers in that state must be a member of. This is a simple regulatory measure that ensures that companies don’t just sell policies and vanish into thin air, and that policies that are sold in your state have some security to them.
In each state, this guaranty association insures the policies that are sold by the members of that association. What that means for you is that your term life insurance policy is guaranteed up to a certain amount, even if your provider goes out of business.
That amount varies from state to state. You’ll want to look up that amount by going to Google and searching for your state plus the term “life insurance guaranty association”. The website you find will indicate the amount that your policy is insured for.
If the amount you calculated earlier is greater than the guaranteed amount in your state, you should buy two separate policies from two different companies. That way, you have two fully guaranteed policies instead of one partially guaranteed policy.
This will likely cost you a higher total premium than one policy but, as I mentioned above, life insurance is a “peace of mind” product and this will ensure your peace of mind.
The Path Forward
Once you have selected your policy, your life insurance bill should become one of your most important bills each time you receive one. Make sure this bill gets paid. If you don’t pay it, then you’re no longer insured and, since you’d be older at that point, getting a new policy would be substantially more expensive.
If you find that changes in your situation changes the amount of insurance you think you’ll need, you can always shop around for another policy. If that happens, you can easily terminate the old one by contacting the insurance company and dropping that old policy. If a life change happens to you, this can end up being a significant money saver.
Owning term life insurance has provided significant peace of mind for me when thinking of the future of my young children. Hopefully, it can provide similar peace of mind for you as well.