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In honor of National Life Insurance Awareness Month, it’s time to once again discuss one of the most dreaded, but important financial planning topics. Life insurance is critical when your death would cause a financial hardship for your survivor(s) or when you need to create liquidity upon your death for estate purposes. In its purest form, life insurance is one of the best deals for consumers. You pay a company a small amount every year to make sure that your dependents are protected in the event of an untimely death. Unfortunately, not enough Americans are choosing to purchase an adequate amount of life insurance coverage. According to the 2016 Insurance Barometer Study by Life Happens and LIMRA, one in three households would have immediate trouble paying living expenses if the primary wage earner died. Part of the problem is that people just don’t like thinking about this topic. But another factor is that the industry can sometimes stray from the simple and effective solution, leaving would-be policy owners confused and more importantly, uninsured. The study also found that 40 percent have not bought life insurance -- or more of it -- because they are unsure of how much coverage they need or what type to buy or because it was too expensive. Let’s break down these issues.
How much coverage should you purchase? You need enough to cover living expenses for survivors; the lump sum amount necessary to fund future educational expenses; and/or money to provide for the future retirement needs of the surviving spouse. Years ago, many used “eight to 10 times annual income” to determine the proper insurance amount. But it is now easy to determine your specific needs with an online calculator. If you are using insurance to fund a future estate tax liability, you should use an amount recommended by your estate attorney.
What type of life insurance is most appropriate? There are two basic types: term and permanent. Term is best for those who have a specific insurance need for a defined period of time, like a young couple with kids who have not yet saved a sufficient nest egg to support their survivors in the event of premature death. During the stated term, if the insured dies, the insurance company pays the face amount of the policy to the named beneficiary. Premiums for term policies are often reasonable for those in good health up to about age 50. After 50, premiums start to get progressively more expensive.
Permanent life insurance is a more expensive option, because it combines the death benefit with a savings or investment component and it remains in force until you die. There are three types of permanent: traditional whole life, universal and variable universal. Whole life policy owners rely on insurance company dividends as the source of accumulation inside the policy. Universal and variable universal life holders invest by using sub-accounts, which are akin to mutual funds, inside the policy.
Permanent life insurance earnings grow on a tax-deferred basis, but you don’t have to die to get your money because these policies allow you to borrow against your cash value. The downside is the hefty price tag. High fees and commissions can eat into those beautiful projected returns and eat up as much as three percentage points from the annual return. Up-front commissions are typically 100 percent of the first year’s premium.
If you are weighing term versus permanent, you may want to consult a fee-only financial adviser, who does not sell insurance, but can evaluate your needs, determine the right type of coverage and refer you to a reputable life insurance agent.
