There are many good reasons to consider buying a life insurance policy, such as a recent marriage, a new baby, or taking on a large debt like a house. Loved ones would have trouble paying off if something happened to you. Or perhaps you have witnessed first hand the impact that a death has on surviving family members’ finances.
If you’re in the market for life insurance or have recently bought a policy, make sure you don’t put your family’s finances in jeopardy by making these mistakes.
KEY TAKEAWAYS
- Life insurance can offer a measure of financial reassurance to your loved ones if something were to happen to you.
- The younger and healthier you are when buying life insurance, the lower your premiums are likely to be.
- It’s important to compare various types of life insurance to find the policy that’s right for you and your financial situation.
- Permanent life insurance covers you for your entire life and accumulates cash value over time. Term insurance only lasts for a certain number of years (e.g., 20 years) and has no cash value.
- It’s possible to own more than one life insurance policy, though you may be required to complete a medical exam to qualify for each one.
Getting Life Insurance
Life insurance is a financial contract that pays out a death benefit to one’s heirs or other beneficiaries in the event of their death. The purpose of this death benefit is to replace any current and future income lost due to that death, to cover any outstanding debts and obligations of that person, and to leave some additional money as an inheritance or legacy.
Life insurance today exists in a competitive marketplace, with many companies offering several types of policies and products. Term life insurance is the most basic form of coverage, providing a level death benefit for a set period of years (e.g., 20 years). Once the term runs out, you will need to reapply for new coverage if you so choose. Permanent life insurance can last your entire life and often comes with a cash accumulation component. The premiums on these types of policies tend to be more expensive compared to term but also come with additional benefits and value.1
Regardless of which type of insurance you decide to go with, the application process will be similar. You will need to provide your basic information, financial picture, and complete a health survey. In addition to the survey, you will often have to undergo a paramedical exam, during which a trained healthcare professional will examine you and may request a sample of blood and urine for analysis. This is because life insurance rates are linked to the statistical probability that you will die and the insurer will have to pay out a claim.
As a result, insurance premiums are often the lowest for younger people (who are often healthier and have longer lives) and for healthier people. Those with health conditions or who have riskier lifestyles (e.g., smokers) can expect to pay more.
Once approved, you will have to pay regular policy premiums (which can be set anywhere from monthly to annually). So long as you continue to pay your premiums, the policy will remain in force; otherwise, it may lapse and your coverage will be forfeited.
Mistake #1: Waiting to Buy Insurance
When purchasing life insurance, it’s important to consider the amount of coverage you need as well as the cost. Life insurance premiums are based on several factors, including your age and overall health.
Buying a life insurance policy sooner, rather than later, can work in your favor if you’re hoping to secure a policy at the lowest possible cost. Life insurance rates generally increase as people age or their health deteriorates. And, in some cases, illnesses or health problems may make you ineligible for coverage. The longer you put off the buying decision the more the insurance will probably cost, if you can buy it at all.
In addition to completing a health questionnaire, you may be required to complete a paramedical exam as part of the life insurance underwriting process.
Mistake #2: Buying the Cheapest Policy
While it is important to shop for a policy that’s affordably priced, it’s important to consider what you’re getting in return, in terms of coverage. Life insurance policies can be a bit complicated, so it’s a good idea to learn about their features and benefits.
For example, term life insurance tends to be cheaper than permanent life insurance.2 But there’s a caveat: term life insurance only covers you for a set time period while permanent life insurance can cover you until death, as long as your premiums are paid.
If you believe you’ll only need life insurance for a set period, say 20 or 30 years, then a term life policy can be an affordable option. On the other hand, if you’re interested in lifetime coverage or you want to own a life insurance policy that builds cash value as an investment vehicle, then it could be worth it to pay more in premiums for permanent coverage. Try comparing the quotes of different life insurance policies to determine what you might be giving up in exchange for a cheaper deal.
The question of whether term or permanent coverage is better will depend on a case-by-case basis, depending on your insurance needs and financial situation. If you buy a term life insurance policy and then later decide you want lifetime coverage, you may be able to convert your existing policy to permanent life insurance.
Mistake #3: Allowing Premiums to Lapse
When purchasing life insurance, you’re expected to pay a premium in return for coverage. Again, these premiums can be based on your insurance risk class, which correlates to your age, health, and other factors. If you’re considering buying a universal life policy with secondary guarantees, such as low-premium guaranteed death benefits for life or for a specified period of time, a late payment can impact the policy benefits.
Universal life is a special type of permanent policy that has been marketed as having long-term guaranteed protection at the lowest possible rate. It is very different from term insurance. While many of these types of policies have a cash surrender value, universal life with secondary guarantees focuses on maximizing the amount of insurance available per dollar of premium.
Some of these policies can be sensitive to the timing of premium payments. For example, if you happen to miss a monthly payment or are more than a month late sending in your check, your guaranteed policy may no longer be guaranteed. A policy purchased with guaranteed coverage to age 100 might only provide protection to age 92 if one payment is late or missed, which could be problematic if you live longer.
Check with your company if you think you’re going to be late on a payment; many will allow 30 to 60 days without changing the policy’s guarantee.
Mistake #4: Forgetting Insurance Is an Investment
The Financial Industry Regulatory Authority (FINRA) considers a variable life insurance policy an investment, so it is important for you to treat it as one too.3
A variable life insurance policy is a permanent type of policy that provides life insurance protection with cash value. Part of the premium goes toward life insurance, and part goes into a cash-value account that is invested in various investments similar to mutual funds that you choose.3 Like mutual funds, the value of these accounts fluctuates and is based on the performance of the underlying investments. People often look to these policy values in the future as a source of funds to supplement their retirement income.
You must fund a variable life policy sufficiently to maximize its cash value growth. This means continuing to make adequate premium payments, especially during times of poor investment returns. Paying less than originally planned can have a big impact on the cash value available to you in the future. It’s also important to monitor your policy’s performance and periodically rebalance your accounts to your desired allocation, just as you would with any investment account. This will help ensure you’re not taking on more risk than you had planned when you set up your account.
Mistake #5: Borrowing From Your Policy
Permanent life insurance policies that accumulate cash value could be a source of funds when you need to borrow money. The cash value of a permanent policy can generally be used for any reason you see fit, including tax-free withdrawals and loans, if done properly.4
This is a great benefit, but it must be carefully managed. If you take too much money out of your policy and your policy lapses, or runs out of money, all the gains you’ve taken out will become taxable. Not to mention, you may significantly reduce the death benefit that’s available to your beneficiaries when you pass away.
If you have taken too much money out and your policy is about to lapse, you may be able to maintain the policy by making additional premium payments, assuming you can afford them. When accessing your life insurance policy’s cash value, be sure to monitor it closely and consult your tax advisor to avoid any unwanted tax liability.
Taking a life insurance loan is different from tapping policy benefits prematurely through an accelerated death benefit rider.
Can You Have Multiple Life Insurance Policies?
There’s no rule issued by life insurance companies that disallows you from owning multiple life insurance policies. And there are some scenarios where it may make sense to do so.
For instance, you may have purchased a $250,000 term life policy at age 30, only to decide at age 40 that you need more coverage. You may choose to purchase a second $250,000 term life policy to close any gaps in your financial plan. Or, you may opt to own both a term life policy and a permanent life insurance policy.
There are some things to keep in mind about owning multiple life insurance policies, however. First, multiple policies mean multiple premiums. If you’re purchasing different policies at different times, you may see a wide range between the highest and lowest premiums, depending on your age and health.
Applying for multiple policies may also mean having to submit to multiple paramedical exams. These exams are conducted as part of the underwriting process and typically involve submitting blood and urine samples, as well as having your blood pressure and other vitals checked. While these exams are usually brief, scheduling several of them may be inconvenient.
Keeping up with multiple policies can also complicate things, especially if you’re using several permanent life policies as an investment tool. It could increase the odds of overlooking a premium due date, which could cause one of your policies to lapse.
Consider talking to your insurance agent or financial advisor about the pros and cons of owning multiple life insurance policies and what tax implications that might have, if any.
What Is the First Thing You Should Do Before Buying Life Insurance?
Buying life insurance is a process, and there is a market for insurance products. First, evaluate your financial needs and goals, and what type of coverage is best for you in order to cover those needs and goals in the event of an untimely death. Make sure you decide on both the right type of coverage (e.g., term vs. permanent) and the correct death benefit amount. Then, shop around for the most affordable coverage from a reputable insurer that can meet your needs.
How Long Does It Take to Receive a Life Insurance Death Benefit?
Life insurance companies typically pay out death benefit money within 60 days of making a valid claim.
What Factors Should I Consider When Getting Life Insurance?
First, determine how much coverage you need. There are several rules of thumb for arriving at the right amount of coverage, such as replacing several years of lost income along with any debts and other obligations you may owe now or in the future.
Next, decide whether term or permanent insurance is best for you. Term policies have lower premiums but they expire after a set number of years. They also do not accrue any cash value.
Regardless of type, insurance premiums will increase with age and are more expensive for those in inferior health.
Are Life Insurance Payouts Taxed?
Death benefits on life insurance policies are given to beneficiaries income tax-free. If, however, the death benefit increases the value of the deceased’s estate over the estate tax limit, it may be subject to estate tax.5
What Is the Best Age to Buy Life Insurance?
The younger and healthier you are, the lower the premiums on any life insurance will be. Therefore, many recommend buying a policy in your 20s if possible, even if you feel that you don’t “need” it at the time.
The Bottom Line
The decision to buy life insurance is an important one. Before committing to a policy, make sure you do your homework, read your insurance contract carefully, and understand all of its provisions. While losing or never buying life insurance may not ruin your life, it will certainly hurt the people you’re buying it to protect.
