Ask Stacy: Is Life Insurance Necessary?

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This week’s reader question is about life insurance, and it’s short and sweet.

Is life insurance really necessary if you are a single person with no dependents? – Pam

Before I answer Pam’s question, check out the following short video, then read on.

Who needs life insurance?

Life insurance is one of the least understood major expenses. Many people buy it when they don’t need it. Just as many need it and don’t buy it.

You need life insurance if those depending on your income would suffer financially from your death. The most obvious example is when you have kids, debt and a one-earner household, because the death of the breadwinner would be financially tragic.

When you’ve paid off the house, the kids are gone, the savings account is topped off, and your death is just an excuse for your remaining friends to get together and have a drink, your need for life insurance is over.

Of course, there are those between these two extremes. For example, because Pam has no dependents, she probably doesn’t need life insurance. But she may have an awesome home she wants to leave debt-free to her sister. If that home has a mortgage, she may choose to get enough insurance to pay it off.

Another situation where life insurance can come in handy is a big estate. In 2014, you can leave an estate of $5.34 million without owing any federal estate tax. Amounts above that exemption are taxed at 40 percent. Some people use life insurance to pay that tax bill.

For most of us, however, the need for life insurance is easy to gauge. Simply ask yourself who would suffer financially by your death, and how badly. If it’s bad enough to justify paying premiums, start shopping.

Here’s how to do it right.

1. Shop

Many sites have insurance search tools that can help you compare quotes and features. But remember that no online insurance search engine includes all companies, and many only include companies that pay to be represented. So don’t expect online search tools to be either complete or completely objective.

If you’re seriously shopping, more due diligence is in order. Check several search sites and beat the local bushes as well.

2. Buy term

There are two basic types of life insurance:

  • Permanent, or whole life. As the name implies, these policies offer a lifetime of coverage. They also combine a savings account and life insurance contract, allowing you to tap the savings component, known as cash value, should the need arise.
  • Term insurance. This insurance has no cash value and covers you for a specific term, from one year to 20 or more. If you die during that term, your beneficiaries get a check. If not, you’re out the premiums.

Because permanent insurance will ultimately pay and features a built-in savings account, it sounds like the way to go. But most people should buy term. The reason is simple: It’s cheaper. Unless you have a big estate, you don’t need insurance forever. You need it when you’re young, in debt and raising a family. You don’t when you’re older and no longer have people depending on your income.

3. Don’t buy more than you need

Depending on a commissioned salesman or online calculator to determine how much life insurance you need is a bad idea.

Many calculators don’t take Social Security survivor benefits into account. They might assume you want to leave enough so your spouse and children can live forever off the interest alone. Or that your kids plan to attend Harvard. Or that your mortgage balance isn’t decreasing with every payment you make. Or that your spouse might go back to work.

In short, this isn’t an exact science. Maybe you want to leave your survivors wealthy, or maybe you just want to leave enough to pay for your funeral. But if you leave it up to a company-sponsored calculator or commissioned salesperson, expect a big death benefit and a big premium to go with it.

Better idea? Figure out what your death would mean financially to your family and determine their needs, both short term (paying for your funeral) and long term (paying off the mortgage, college costs, etc). When you’ve arrived at an estimate, subtract the money you have now or can expect from Social Security or work-related policies, then cover the shortfall with insurance.

4. Stay away from commissioned salespeople

Woody Allen once said, “There are worse things in life than death. Have you ever spent an evening with an insurance salesman?”

While Allen was referring to boredom, he could have been highlighting another drawback of commissioned salespeople. Simply put, the more you buy, the more they make, so they’re not objective.

But avoiding commissions doesn’t mean avoiding expert help. There are plenty of fee-only planners out there who can help you evaluate your need, then steer you to low- and no-commission policies, like those from TIAA-CREF and Ameritas. Sure, you’ll have to pay for the adviser’s time, but you’ll more than offset the cost with less expensive insurance and peace of mind.

5. Avoid guaranteed issue (if you can)

Ever see a TV commercial – usually directed at older folks – offering insurance with no medical exam and insisting “you can’t be turned down”? That’s guaranteed-issue life insurance.

It doesn’t take a rocket scientist to figure the angle: The death benefit is so low, the first few years of premiums may add up to more than your beneficiaries will receive.

Avoiding a physical sounds convenient, but you’ll probably get a better deal by submitting to one, even if you’re not in the best of health. If you know for a fact that you’re uninsurable, you may not have a choice. But if you have alternatives, explore them first.

6. Stay on top of it

While health issues will make your insurance more expensive, getting healthier can mean savings. If you quit smoking, lose weight, or make other life changes that lower the risk for the insurance company, don’t be afraid to contact them and ask for a reconsideration. But be prepared to provide proof, such as an extensive medical history, to get a lower rate.

Health isn’t the only thing that can lead to changes in your policy and premium. Have a new baby? You might need more insurance. Pay off the mortgage? Might need less. Periodically re-evaluate your coverage needs and costs.

If you need to increase your coverage, you may be able to do so less expensively by buying a rider (an addition to an existing policy) rather than taking out a new policy.

7. Don’t buy it on kids

Unless your child is contributing financially to your family, you don’t need to insure their life.

As with the whole life vs. term argument, this is advice not fully embraced by everyone. There are those who insist that buying a permanent policy for infants is a good idea, for three reasons:

  1. If they should later develop a health condition that renders them uninsurable, at least they’ll have some coverage.
  2. Although it’s certainly more rare than with seniors, children die.
  3. They’ll establish a permanent savings account.

While these are valid arguments, they’re not enough to convince me, or most objective advisers. Sure, children can develop a health issue rendering them uninsurable, and they can die. But the odds aren’t high enough to pay for protection, especially for the high-cost kind that accompanies many whole life policies. A savings account for kids is a great idea, but there are lower-cost ways of going about it.

Bottom line? You don’t have to be an expert to know whether you need life insurance. You just need to think about what would happen if a paycheck suddenly vanishes. If you have the need, do some reading, do some shopping and take action. If you need help, find it. But don’t rely entirely on online calculators or commissioned salespeople.

Got a money-related question you’d like answered?

You can ask a question simply by hitting “reply” to our email newsletter. If you’re not subscribed, fix that right now by clicking here.

The questions I’m likeliest to answer are those that will interest other readers. In other words, don’t ask for super-specific advice that applies only to you. And if I don’t get to your question, promise not to hate me. I do my best, but I get a lot more questions than I have time to answer.

Got any words of wisdom you can offer for this week’s question? Share your knowledge and experiences on our Facebook page.

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Comments & discussion

We welcome your opinions, but let’s keep it civil. Like many businesses, we reserve the right to refuse service to anyone. In our case, that means those who communicate by name-calling, racism, using words designed to hurt others or generally acting like an uninformed bully. Also, comments that include links to email addresses or commercial websites typically aren't posted. This isn't a place to advertise your business.

  • Gars

    Read the books:

    Insurance for Dummies by Jack Hunglemann

    The Invisible Bankers by Andrew Tobias

  • Kenneth Isgrigg

    Life insurance for children: It depends. I have a $10k policy on my daughter through work that costs less than 2 dollars a month. Considering the cost of burial and services (God forbid), this sounds like an unbeatable deal to me.

    • Gars

      Do you know the odds of your child dying this year? The insurance company does. Without you knowing those odds, how do you know how much risk you are really taking? The insurance company knows.

      • Patrick Seitz

        They know that after a few months old, it’s unlikely which is why they’re only charging $2 a month. I wouldn’t lose any sleep over that amount.

  • Alicia Whitehead

    I protected my son at 4 months old with a Universal Life Insurance Policy. This protects his insurability. With the way diseases and illnesses are preventing people getting insured and especially children diseases, it was important to me to protect him and if anything were to happen to me down the road he would already have the coverage for his family. I am building a legacy. At certain ages with his policy he will be able to double the value of the $25k policy regardless of his medical insurability. As well the inevitable does happen and know those that have dealt with this. It is a smart financial decision to protect your assets and protect your children’s future insurability.

    • Chuck Ferguson

      The Universal Life was a good choice Alicia. I posted a while ago pointing out that Term life insurance is actually one of the most expensive types of insurance, but I guess monitors didn’t like it. Only 1% of all term insurance results in death claims. In other words, 99% of policy holders end up with zero. The lower annual cost means nothing if all of your premiums are lost. That is extreamly expensive insurance.

      • Gars

        Term life is pure insurance. I bet I die this year, they bet I don’t. I lose either way, but my heirs win if I die.

        I prefer to buy term insurance and invest the difference between term and whole life or universal life in a humble Total Stock Market Index Fund.

        The insurance company still makes money off me from the life insurance, but Vanguard is charging me only 0.07% each year to manage the index fund.

        • Alicia Whitehead

          Gars, I know that through Whole life you can manage to invest into it, make it pay your mortgage for the last 15 years of a 30 year mortgage, all the while still claiming your interest. This is because through whole life you don’t have the fees and taxes associated because you can draw from it. There are definitely different views created based on what one has experienced in their life. For me, I currently have term because it is all I can afford and I want to provide for my child if I were to leave him before he could take care of himself. To provide for him is my only need at this time. However I do plan to obtain a whole life policy and make it work for me, instead of life insurance working against me.
          Chuck, you are correct. Several years ago I believe the statistic was 4% of term life was actually paid out, but with the longevity now I believe it has changed that drastically.

          • Gars

            First, If you can’t afford a house on a fixed, 15 year mortgage, you can’t afford the house. Period. 30 years makes the banker rich, not you. You need to find an adviser that can convince you of this as well as the benefits of pure term insurance. Whole life insurance is a terrible investment. It only has merit if you would spend the money rather than save and invest it yourself.

            You really need to read the book Invisible Bankers by Andrew Tobias, Chapter Gerber Life Like Taking Candy From a Baby. Any reason you can’t go to the library and get or request that book and read the chapter to understand what you’re really doing for you child?

    • Gars

      Put your feeling aside and look at the actuary science. Read the book, The Invisible Bankers, chapter, Gerber Life– Like taking Candy from a Baby. Then rethink your conclusions.

  • Maximus

    First, I appreciate the objective article on life insurance. Too often you have people writing articles that push life insurance no matter what the person’s circumstances are. I also want to offer a different perspective that is not often considered…probably because life insurance has been made out to be a wonderful thing and everyone should have it. This is more marketing and image than reality. I would argue that life insurance in most cases is NOT a good idea. When I hear people talking about leaving a “legacy” and “protecting” their loved ones, I cringe a little bit. Mainly because this is how insurance salespeople pull at your heartstrings and convince you that you can’t live without life insurance. If you take a step back and really look at life insurance, it’s basically like going to a casino in Las Vegas and putting a bunch of money down on one hand of poker or slot pull. The house ALWAYS wins. With life insurance, the house (or the insurance company) ALWAYS wins. Why is that? Because the odds are in THEIR favor. The probability of any one person dying before the age of 65 is very small. There are actuaries and statisticians sitting at computers as we speak calculating this probability and it’s less than 3%. Why do you think insurance salespeople make so much money on life insurance policies as opposed to homeowners insurance? It’s because insurance companies bring in a ton more money than they pay out for life insurance. Home insurance policies are about break even or a loss. This is why insurance companies want to have you car, home, and life insurance with them. They don’t make money on home insurance but they do on car and life. There are some situations where life insurance may be worth a look like if you work in a dangerous environment or if you have a history of people dying early in your family. But for the average person, the chances of you dying before 60 is very slim. And what do you think insurance companies do with your premium? They invest it an make more money. That is exactly what YOU should be doing. Save your money and invest it. That way you can also benefit from the money while you’re alive. Just something to think about…

    • Alicia Whitehead

      I definitely respect your opinion and appreciate your look on it because you are correct. Definitely a great way to look at it.

  • Alicia Whitehead

    On the term policy that I have I can turn it over into a whole life or universal life at any time regardless of my insurability. After I obtained this policy I was involved in an accident that stopped me from being able to obtain the disability rider, where it would pay for itself if I became disabled. I can no longer obtain this and I plan to turn it into a whole life policy in the near future where i can take this rider with me.