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.
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:
- If they should later develop a health condition that renders them uninsurable, at least they’ll have some coverage.
- Although it’s certainly more rare than with seniors, children die.
- 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.
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