Photo (cc) by Leonid Mamchenkov
Though it’s not much fun to think about — and we may put it off like that root canal we need — getting life insurance is a good idea for most people: What it does, upon your death, is provide funds for surviving family members (or whomever you have designated), helping them to cover costs such as mortgages, unpaid debts, college tuition and your funeral costs. But what kind to get, and how much coverage to get can vary a lot depending on your circumstances.
Here’s a way to navigate those waters, so you can get the right life insurance policy in place, and then move on with life.
How it works
There are two main types of life insurance:
Term life: These policies provide a set amount of coverage for a fixed rate of payments for a limited period of time — or term. Under this policy, if you die during the term, benefits are paid to the person you chose as a beneficiary — typically a spouse or children. After the term runs out, there’s no guarantee that you will be able to get the same level of coverage at the same rate. You can either purchase a new life insurance policy at new terms, or let it lapse. It’s a relatively affordable way to make sure there is a substantial amount of money for children or other dependents if you should not be there to provide for them.
Term life policies can be set for various periods of time — but typically for no longer than 30 years.
“Term is like renting the insurance,” says Aprilyn Chavez Geissler, a board of trustees member for the National Association of Insurance and Financial Advisors. “When you rent an apartment, you don’t get any equity. All of the money you pay in is for a period of time; it goes away at the end of the term.”
In other words, what these policies provide is pure death-benefit protection for a given period of time.
Whole life: As the name suggests, these policies remain in force until you die, regardless of your health, so long as you continue to pay the premium. These premiums are generally higher to start with than those paid for term life policies.
In addition to providing death benefits, these policies are also designed to provide other “living benefits,” including guaranteed cash-value accumulation and eligibility to earn dividends. As a whole-life policy holder, you can have tax-deferred access to that cash value to, say, help cover a down payment on a home, to help fund your children’s education, or to provide retirement income.
There are a couple of different types that vary in the ways that they accumulate cash value (and the risk of losing cash value) depending on the way that your funds are invested to generate income. From least to most risky, they are:
- Traditional whole life insurance
- Fixed universal life insurance
- Indexed universal
- Variable universal
Term life insurance is the best choice for many people, especially for younger people getting their first such policy, according to Jason Dana, vice president of sales for San Diego-based agency JRC Insurance Group, and other experts. It’s typically more affordable than whole life insurance.
Chavez Geissler, who also owns an Albuquerque insurance and financial service agency, says term life insurance is great for young couples with children. For a relatively low monthly premium these policies make sure that spouses and children will have a substantial safety net for getting those kids to adulthood if the insured person dies. Meanwhile, these couples can concentrate other funds to pay off a mortgage and save for their children’s college education.
“It’s also very often the product of choice when protection needs may be high for a period of time, such as when your family is growing,” according to New York Life Insurance, which focuses on selling whole life policies. “Term life can also be an effective way to supplement permanent insurance during high-need years, such as when family and other financial responsibilities are outpacing income.”
Typically there are no penalties for canceling term life policies at any time, but there may be penalties and tax consequences for ending whole life policies early.
The downside of term life policies is that they do eventually expire. If the policy was intended to provide for a child, by the time it expires, the beneficiary is probably a self-sufficient adult, and the policy is not needed.
Another aspect of term life insurance that policy holders need to understand is that after the first term is over, the premiums typically increase substantially per year. To save money, Chavez Geissler recommends people then start a new term policy or convert to a whole-life insurance policy.
Overall, whole life insurance policies are more expensive but they have the advantage of growing in value — with substantial growth potential for the highest-risk policies.
Chavez Geissler says the indexed universal and variable universal life insurance plans are best for more affluent people.
What type do you need?
To figure out what type of life insurance policy and how much coverage you should get, she recommends people consider Debts, Income, Mortgage and Education or DIME:
- Debts: How much debt do you have and what are the minimum payments?
- Income: If you were to die today, how much income would your spouse lose and how long would it take them to get back on their feet?
- Mortgage: How much is it and when will it be paid off?
- Education: How much money will your children and/or spouse need to get a college education?
To get a better idea of how to arrive at an appropriate number, check out a term life insurance calculator like this one for TIAA insurance. (We’re not endorsing the insurance they sell, but the calculator provides a useful illustration.)
So, for example, if you input the following profile — male, age 40, height 6 feet, weight 200 pounds, nonsmoking, living in Washington state — the calculator generates the following quotes:
- 20-year term life policy worth $100,000: $14 per month
- 30-year term life policy worth $100,000: $21 per month
- 20-year term life policy worth $500,000: $74 per month
(As TIAA notes on the website, these are only estimates. In addition, it notes that whole life policies are more complex, so it’s best to call for details on premiums and benefits.)
Chavez Geissler generally recommends that a couple earning $75,000 altogether, raising two children and paying a mortgage each get a $500,000 term policy for 20 years on their spouse.
But even a small life insurance policy can make a difference in the event of a death.
“It’s even the small ones, like $10,000 policies, [that] are more important and meaningful to people that are lower income,” says Chavez Geissler. “It’s more profound to the families that are barely making it.”
When to buy
In general, the sooner you get a life insurance policy, the less expensive it’s likely to be. That makes sense, since insurance companies charge premiums according to the risk that the insured will die. You may find that getting a policy later in life can get prohibitively expensive, especially if you have major health problems such as obesity or cancer.
“You’ll never be healthier than you are today, and you’ll never be younger,” said Dana, of JRC Insurance Group. “You might as well try to get the life insurance when it’s going to be the least costly.”
Have you explored life insurance policies? What’s your experience? Share with us in comments below or on our Facebook page.