6 Questions You Need to Ask Before Buying Life Insurance
Simplifying a scary, complex and often ignored subject
My first job out of Undergrad was selling life insurance.
I hated that job, but there is one lesson I learned that will stick with me forever:
“Nobody wants life insurance when it’s cheap and easy to get, but once you need it, the cost will be high if you can get it at all.”
In this edition of Dollars & Decades, I review 6 questions everyone should ask before buying life insurance.
Question 1: How much life insurance coverage do I need?
In the world of life insurance, your “coverage” is the amount your beneficiaries receive when you die.
Ideally, your insurance coverage should ensure your beneficiaries are just as well off financially as they were when you were alive.
Here are 11 factors to consider when deciding on your coverage.
Income Replacement: Calculate how many years of income you need to replace. A common approach is to aim for 10-15 times your annual income, considering inflation and future salary increases.
Debts and Liabilities: Add any outstanding debts like mortgages, car loans, credit card debts, or personal loans. Ensuring these can be paid off relieves your family from financial burdens.
Education Expenses: If you have children, consider the costs of their education. Include tuition fees for school and potentially college or university.
End-of-Life Expenses: Account for funeral costs and any medical bills that might be outstanding at the time of death.
Emergency Fund: You might consider including an additional amount for unforeseen expenses or emergencies that your family might face.
Spouse’s Retirement: Consider whether you want to contribute to your spouse's retirement savings, especially if your income was a significant part of your retirement planning.
Inflation: Over time, the value of money decreases due to inflation. Factor in an average inflation rate to ensure the coverage amount maintains its value over the years.
Existing Assets: Subtract any existing assets like savings, investments, or current life insurance policies that can be used towards these expenses.
Spouse’s Income: If your spouse works, you might reduce the coverage amount accordingly, especially if they can cover some living expenses independently.
Age and Health: Younger individuals with dependents typically need higher coverage compared to older individuals whose children are financially independent.
Policy Term: For term life insurance, many people align the term with their longest financial obligation, like a 30-year mortgage, or until their dependents are expected to be financially independent.
You need to remember that the more coverage you have, the higher your premiums will be. It’s important to balance your insurance needs with your current budget.
Here’s something I’ll repeat a lot: A reputable financial advisor (be weary of insurance salespeople) can be worth their weight in gold to help you work out your ideal coverage amount.
Question 2: What’s the difference between term and whole life insurance?
Term Life Insurance
Term life insurance provides coverage for a specific period or "term" (typically 10, 20, or 30 years). If you die during this term, the policy pays a death benefit to your beneficiaries.
Key Features:
Fixed Term: Coverage is only for a predetermined period.
Lower Premiums: Generally more affordable than whole life insurance, especially for young people.
No Cash Value: Does not accumulate any cash value over time.
Renewability and Convertibility: Some policies allow you to renew or convert to whole life insurance at the end of the term, often at a higher rate.
Purpose: Ideal for covering specific financial responsibilities like a mortgage, children's education, or income replacement during working years.
Whole Life Insurance
Definition: Whole life insurance is a type of permanent life insurance that offers lifelong coverage coupled with a cash value component that grows over time.
Key Features:
Lifelong Coverage: Remains in force for your entire life, as long as premiums are paid.
Higher Premiums: More expensive than term life insurance, but premiums generally remain constant.
Cash Value Accumulation: A portion of your premium builds a cash value, which can grow over time. You can borrow against this cash value or, in some cases, withdraw from it.
Fixed Death Benefit: The death benefit amount is often fixed and paid to your beneficiaries upon your death.
How to Decide Which is Right for You
I need to be upfront and admit that I have a strong bias against whole life insurance. Back when I sold insurance, I was pressured to shove whole life insurance in front of every prospective client.
Not because it was the right thing for the client but because whole life insurance comes with a big fat commission for salespeople.
Again, each person reading this should work with a trustworthy advisor to determine what is right for them. But the tell-tale sign of an untrustworthy advisor is when the answer to every question seems to be “buy whole life insurance.”