A Beginner’s Guide To Life Insurance

Life is a series of risk management, said a wise oncologist recently.

Death happens and we can’t control our retirement from life.

To better manage our risks in life and provide some protection against loss, we need insurance–auto, health insurance, disability and life insurance.

While car insurance is mandatory (except in New Hampshire) and health insurance was mandatory under the Affordable Care Act (until 2019), life insurance is not required.

Let me give you some of my thoughts here

If you are young, married, and have children or are planning to grow your family, life insurance is a must.

Term life insurance is a better option than the cash value policies. Some find the cash value policies attractive for their lifetime nature, savings and investment elements but I feel term life values offers more value with generally lower rates than the cash value options.

How much life insurance coverage do you need?

Although there are rules of thumb of some multiple times your annual salary to figure out what amount of life insurance coverage you should target, there is a danger with that simplicity.

Are you using your annual salary that is your starting salary at age 25 or 30 years old? More relevant is to consider what your family plans  and what costs are you trying to cover?

If you are like most your young people, you likely don’t have a long range plan with all the pieces in place but you take some educated guesses.

You can also use some insurance calculators and you are likely going to find that the difference in your monthly cost between a $1 million and $2 million policy may be the cost of one non-lavish dinner out.

If it is a fixed amount, you find it easier to pay more as you earn more. Do what is better for your family and your piece of mind.

“Insurance is the only product in the world that both the seller and buyer hope is never actually used.” Author Unknown

What is life insurance?

A life insurance policy is a contract with a life insurance. The contract is typically bought by the primary wage earner in a household.

The purchaser of the policy and now insured makes premium payments to the insurance company in exchange for a lump-sum payment known as death benefit to the beneficiaries upon the insured’s death. The death benefit is typically income tax-free.

Who needs life insurance?

If you are young and unmarried you probably don’t need life insurance now. However, if  you have a loan that has your aging parents as guarantors, you want to get an insurance policy to cover your debts.

If you are young, married and without children, you may not need to buy life insurance but it will be cheaper, and especially if you may have a mortgage or student loans that someone else such as your spouse will have to face in the  unlikely event of your death.

If you are young, married and have children below 18 years, you definitely need a life insurance policy. If you have a workplace life insurance policy, check what coverage amounts you have. There is a good chance you don’t have enough and need to get a bigger policy. At the very least, if you need a life insurance policy, and you do, im my opinion, as you will see below, term life insurance is the way to go.

Older households that are married with children need life insurance. The median age for owning a life insurance has increased to 48 years in 2013 from 42 years in 1989. This is not surprising as people are marrying and having children later.

The impact life events that often motivate purchase of a policy are highest when having children (43%), buying a home (35%) change in financial situation (33%) and marriage (28%) according to surveyed buyers in a Deloitte study.

There are two main types of life insurance: Term Life and Permanent Life

Term life insurance provides financial protection for a specific time period, usually 10-30 years. The longer the time frame, the higher your premium costs will be.

Traditionally, the premium payment for term insurance remains the same throughout the coverage. Other term life policies may have premium pricing changes at predetermined intervals, with rates rising with age.

Term life is generally cheaper than permanent life insurance and usually provides the value and flexibility.

Term life insurance is intended to replace lost potential income during working years.

In the event of the insured’s passing, the family’s goals can still be met such as paying off a mortgage, paying other debts, paying for your children’s college and keeping a business running. As mentioned earlier, the death benefit is not taxed.

Term life insurance can be extended beyond your purchased time frame but at higher rates and is not guaranteed if you developed a serious health problem.

Diabetes or heart disease may run in your family and so added protection is desirable.

Your best bet is make sure your policy comes with a non-cancellable guaranteed renewable term insurance provision. Check to see how many times your insurer will allow you to renew your plan as well as an age cap.

Term life insurance is better but consider permanent life insurance for lifetime coverage

Term life insurance does not have a cash value growth potential like the permanent life insurance. Frankly the savings you earn between the lower priced term life versus whole life or universal life insurance can be invested in a low indexed S& P 500 fund and keep pace or exceed the growth of the permanent life insurance options.

Permanent life insurance: whole life insurance and universal life insurance.

These options have cash values that pay benefits upon the death of insured and have a savings/investment element.

The insured, while alive may surrender or cancel the policy for cash value, withdraw or borrow from the insurance company against the policy. The beneficiaries do not have this ability but presumably the insured is doing something to benefit his or her dependents.

Many holders of these cash value policies do not hold the policies through the death benefit. It could be that your children have grown, your mortgage is paid off, or your have pressing needs for the cash.

Whole life is more popular than Universal life

Whole life insurance, the more popular of the cash value policies, is designed as lifetime coverage. The premiums are paid with fixed amounts and are typically more expensive than term life.

Whole life has a savings component and may accumulate tax-deferred investment money over time. There is no need to renew for coverage to remain in effect  though you may be making fixed payments throughout your life.

Some of the whole life policies allow for limited pay until a certain age such as 100 years, or allow for modification adjustments to the components, such as paying lower amounts in your early years.

Universal life insurance policies may be more flexible. The owner of this policy may choose to pay a smaller or larger premium.

Like whole life, the policy is generally designed for lifetime coverage. Universal life insurance provides both a death benefit and building cash value with greater growth potential based on a rate of return paid by the insurance company.

This policy may require annual fees to net a certain return. I generally do not believe insurance policies are not adequate as an adequate investment strategy. The universal policy is often seen as part of estate planning strategy.

Cash value policies are better for those who want lifetime coverage, have plenty of cash to invest and want to use your life insurance policy as more diversification. Be aware that you may owe taxes at the ordinary tax rate for the difference between the amount of your policy premiums and the cash proceeds you receive when cashing out your policy. Consult your accountant to be sure.

Some statistics from LIMRA, about life insurance reflect some common misperceptions:

60% of all people in the US were covered by some form of life insurance in 2018 either through an individual policy or through their workplace. That percentage has remained at 60% in the past few years but a significant drop from 77% household  life insurance ownership in 1989.

Buy Both Term Life and Whole Life

There is a strong argument for families to combine these policies. While term life is more affordable, it is not permanent coverage like whole life insurance. If you are looking for $1,000,000 worth of coverage, you may want to consider buying $500,000 worth of term life coverage at a lower premium while adding $500,000 worth of whole life.

You may have purchased life insurance early in your lives when you had one child living in an apartment. However, lives change and you now have three children and live in a sizable house. Your compensation is also considerably higher than it was previously. You now can afford permanent protection and can add whole life to your term policy.

Life Insurance: 1965 vs. 2017

Looking back to 1965, Americans bought 27 million life insurance policies compared to 28.04 million policies in 2017 according to Statista.

That is only 3.9% growth in purchased life insurance policies in 50 years when our population grew by more than 40% from 1965 to 2017.

Part of the greater appeal of life insurance in 1965 may be explained by the lower life expectancy of 70.21 years (blended for women and men) versus 78.6 years in 2017. The drop occurred for both term life policies and the cash value policies associated with permanent life insurance explained below.

However, the decline in cash value policies is nearly 50% since 1989. In the Federal Reserve Bank of Chicago’s study, face value of term life grew to $353,288 in 2013, up 126% from $155,996 face value in 1989.

Face value of cash value life insurance grew also but at 43.1% indicates far less appeal.

The study indicates significant changes of socioeconomic and demographic trends with the African American households at lower income accounting for a relatively higher percentage of ownership as compared to white households.

Almost 90% of consumers think a family’s primary wage earner needs to own life insurance, a big gap from the 60% who actually own a policy.

More than a third (35%) of households would feel the financial impact if the primary wage earner died.

20% of people who have life insurance say they do not have enough.

It is important to point out that in a separate LIMRA survey on employment based life insurance ownership reported that 108 million people have life insurance through a group plan surpassing 102 million people who own individual life insurance plans for the first time.

The potential problem is that those who do have the work plan often as a free work benefit may be minimally covered  as low as one times the employee’s salary or only $25,000. That is well below the recommended industry standard in the 7x-10x salary for deeper coverage.

 Life Insurance and Millennials

44% of Millennials overestimate the cost of life insurance by five times the actual amount.

Millennials say they need information and education, explaining that they are uncertain about the different types, amounts and qualifying for coverage.

Millennials tend to research life insurance products online more than other generations but would consider buying from an insurance professional.

Only 1 in 3 Millennials and Gen Xers have their own financial advisors versus 40% of Boomers that have a primary financial advisor.

Buying life insurance is more complex than other products. There is a huge opportunity for insurance providers to provide clear information on their websites along with simplifying the underwriting process for new buyers.

Half of all consumers say they are more likely to buy life insurance if it is priced without a physical examination. While that exam is a key factor, it is among other considerations that are less known, such as credit histories, driving records, hobbies and lifestyle.

For example, certain activities like scuba diving, recreational flying, racing, and bungee jumping could impact insurance costs like smoking and alcohol.

61% of consumers don’t buy life insurance policies at all or increase their coverage because they have other financial priorities.

Those priorities differ generationally. 49% of those 65 or older and 60% of Millennials cited paying for expenses associated with Internet, cable, and cellphones over purchasing more insurance. 29% of Millennials pointed to saving for vacations as their priority while 23% of Gen Xers’s priorities were going to the movies, shopping or eating out over buying life insurance.

According to Federal Reserve Bank of Chicago in their 2017 study, the major reasons to buy insurance were:

  • 51% want to cover burial and final expenses.
  • 34% to replace lost income.
  • 26% to pay off mortgage.
  • 24% to transfer wealth to the next generation.
  • Only 14% cited buying life insurance was for supplementing retirement income. This last point may help to explain the mystery of the decline in life insurance ownership since 1989 when a higher percentage of our population were covered by workplace pensions but not yet the increased retirement options such as 401 K plans, IRAs and Roth IRAs which were introduced starting in 1998. Households have to prioritize their needs and retirement planning usually places high up on most people’s lists but are challenging for many.

Your future family plans play a big role in your life insurance policy

I believe that everyone needs a life insurance, especially with those with dependents.

I prefer term life insurance with an adequate amount of coverage to cover all of your debts and college planning and for enough years in the plan to support your family.

The rule of thumb is 7x-10x your annual salary but it may not be adequate for you and your family. If you are using a multiple of seven times your annual salary of $65,000, is $455,000 enough to cover your anticipated expenses?

Is it appropriate to use that multiple on your starting level salary which is expected to grow along with your lifestyle. The difference between a policy

What are your plans for the future? How about some peace of mind

Your life insurance policy should be able to address your family’s plans.

If you are like most young people, you don’t have all the pieces of the puzzle but you can make some educated guesses.

You need to consider whether you will be buying a house, where will you live, how many children are you planning to have?

Do you have student loans and other debt that need to be factored in?

What do you want the plan to cover and for what time frame?

You should use an ample life insurance plan so you can have peace of mind for the long term. There are insurance calculators you can use. You are likely going to find that the monthly difference between $1 million and $2 million policy coverage equates to about one non-lavish dinner out that month.

Have you bought a life insurance policy or considering buying one? Have you figured out your needs based on some long range expectations for your family? What is your experience in this often complex are? We would like to hear from you!

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