How to choose a life insurance policy admittedly isn’t a popular topic. After all, buying life insurance is all about preparing and providing for your departure from this life.
It may not be a particularly pleasant topic. But it’s one of the most important financial decisions you will make.
That being the case, it’s worth it to spend some time deciding how to go about process. And exactly which among the many policy choices you want to settle on.
If you haven’t reviewed your life insurance coverage in several years, or if you have none at all, then now is the absolute best time to do it.
But since it is something of an intimidating process, let’s go over the various steps. We want to help you purchase the right amount of coverage at the best price.
While we’re at it, let’s start with the most basic question of all:
Why Do I Need Life Insurance?
As shocking as this may sound, you actually don’t! After all, you’ll be paying for a policy that won’t provide any benefits until after you’re gone.
But life insurance isn’t designed for the policy owner. It’s for the policy owner’s loved ones and beneficiaries.
Even though you’ll have no need for money after you’re gone, the people you leave behind will. And in all probability, your sudden absence will increase their need for funds.
That being the case, let’s review the reasons why your beneficiaries will need you to have life insurance:
- To cover your final expenses. That will include funeral expenses and related costs.
- To pay off any debts you may leave behind. That can include medical expenses, credit card debt, a loan on a vehicle you want to leave to a loved one, or even the mortgage on your home.
- To provide money for living expenses for your loved ones. That will include anyone who is dependent on your income and financial resources for their survival.
- To provide what might be called adjustment money. The shock of your death may temporarily immobilize your loved ones for a time. Even if they’re not dependent on your income, leaving money to help them deal with your loss will minimize both the emotional and financial stress that will come with it.
- Special case: Student loan debt. Federal loans will be automatically forgiven upon your death. Not so with private student loans, at least not if there’s a cosigner involved. If you die with an open, private student loan obligation—complete with a cosigner—the debt will fall to your cosigner to pay off.
Even if you didn’t think you needed life insurance up to this point, it’s likely you’ll find a valid need in the list above.
How Much Life Insurance Do I Need?
Once you’ve established the need for life insurance, the next most important consideration is how much.
Unfortunately, there’s no easy answer to this question. It will depend on personal circumstances, including your financial obligations.
The general rule of thumb is to purchase life insurance coverage equal to about 10 times your annual income.
But that rule is so generic, it’s nearly useless for most people.
At best, it may serve only as a starting point. From there, you’ll need to make adjustments based on personal circumstances.
Let’s run some examples.
Single Person, with No Dependents and Minimal Debt
If this describes your profile, you may need life insurance sufficient only to cover reasonable burial expenses.
And also any debts you might have that were cosigned by someone else.
Other than that, you may only want to have enough insurance to enable your loved ones to better cope with your death.
A policy of $50,000 or $100,000 may be sufficient.
Married, Self-Supporting Spouse, No Dependents, and Significant Debt
True, your spouse may not need life insurance proceeds to provide for his or her support.
But at a minimum, you want to provide for final expenses, adjustment money, and certainly enough proceeds to pay off any debt you have.
For example, say you and your spouse own a home with a mortgage on it.
You’ll want to be sure your life insurance is sufficient to pay it off. So your spouse can stay in the home comfortably after your passing.
Married, Non-Working Spouse, Two Dependents, and Significant Debt
This type of profile will generally require the largest amount of life insurance.
Not only will you need to cover final expenses, adjustment money, and the payoff of personal and family debt.
But you also need to provide for your family’s support.
This is where the 10-times-your-income rule of thumb comes into play.
You’ll certainly want to start with that number if your children are young and will need to be provided for over many years.
But you may be able to adjust that downward if your children are approaching emancipation.
Especially if your spouse is planning to reenter the workforce.
Business Owner, with a Significant Amount of Business Debt
Many people who are self-employed don’t think much about this as a life insurance-related obligation.
But if you own a business that has substantial debt, you may want to ensure your life insurance policy will provide funds to pay off those debts upon your death.
After all, once you’re gone, you won’t be there to help cover the obligations.
By having sufficient life insurance to pay off any business debts, you can be certain you are leaving your business partners or family members a debt-free business upon your death.
If it is for the benefit of business partners, it will make it easier for them to continue the business in the absence of your contributions.
If it’s for family members, paying off business debts will make it easier for your loved ones to sell the business once you’re gone.
It’s even common for business owners to maintain one or more dedicated life insurance policies specifically to pay off business-related debt.
In that case, the amount of life insurance you’ll need in that policy should roughly match the amount of debt owed by the business.
You Have Enough Money Saved and Invested That You Are “Self-Insured”
This is one of the most common scenarios where you might be convinced you have no need for life insurance. That might be true, but it just as likely won’t be.
Even if you do have enough money that you’re self-insured, there may be estate taxes upon your death that will reduce the money available for your family.
Estate taxes generally don’t come into play when an estate passes through a spouse.
But if it passes through the children or other beneficiaries, those taxes may cut into the money you intend to leave for those beneficiaries.
A life insurance policy can be purchased to cover potential taxes.
You may also want to have a sufficient amount of life insurance available to pay uncovered medical expenses.
A typical health insurance plan will cover the vast majority of medical expenses. But that’s not always the case if your death is preceded by a prolonged illness.
Certain expenses may not be eligible for reimbursement. If so, those expenses may fall to your loved ones to pay out of your estate.
A life insurance policy can eliminate that problem.
What is the Best Type of Life Insurance?
The two most basic types of life insurance are whole life and term.
Whole Life Insurance
Whole life is sometimes referred to as permanent life insurance. This is because it cannot be canceled except for nonpayment of the premiums.
It features a fixed premium and death benefit. And also provides a cash accumulation feature that adds something of an investment provision to the policy.
The disadvantage of whole life, however, is that it’s much more expensive than term.
In fact, the premium for a whole life insurance policy will typically be around 10 times that of an equivalent amount of term life insurance.
Term Life Insurance
Term life insurance is a policy that provides a death benefit with no cash accumulation feature. That’s a major reason why it is so much less expensive than whole life insurance.
And for that reason, you can afford to purchase a much larger policy.
The disadvantage of term life insurance is the time limit. A typical term life insurance policy will run between five and 30 years.
At the end of the term, you will generally be given the option to renew the policy, but at a shorter term.
For example, a 30-year term may be renewable in one-year or five-year increments.
And while the premium on a term policy will remain level until the original term expires, it will increase upon renewal.
That’s because your premium will be based on your age at the time of renewal, not the time of original purchase.
Which Type Life Insurance Policy Should You Choose?
Because of the price differential, whole life is the better choice if you only need a small amount of coverage.
For example, while the premium on a $100,000 policy may fit comfortably in your budget, a $500,000 policy may be a certified budget buster.
Whole life is also a good choice if you have concerns over future insurability. Since it represents permanent coverage, you’ll have it no matter what happens to your health in the future.
The policy can’t be canceled, and the premiums can’t be increased.
But if you need a very large amount of life insurance coverage, and cost is a factor, you’ll want to consider term life insurance.
It costs only about 10% of what whole life does. So you can purchase a policy with a death benefit five times larger at half the premium cost of a whole life policy.
There are other types of life insurance policies, such as universal life, that are more highly specialized.
We’re not going to discuss those in this article. Since it’s likely your need for life insurance is on a much more basic level.
In addition, though universal policies may have more features, they’re not suitable to the vast majority of consumers.
When Should I Buy Life Insurance?
The answer to this question is incredibly simple: now! That’s not a sales pitch either.
Here’s the thing; the two most important factors in purchasing life insurance are your age and your health.
As far as age, you’ll never be younger than you are today. Five years from now, you’ll be five years older. And the premium you’ll pay will be commensurately higher.
That will be the case whether you purchase a whole life or term policy.
In most respects, health is an even bigger variable. If you wait to purchase and develop a significant health condition before you do, you’ll pay a higher premium still. In addition to the age adjustment.
But an even bigger nightmare scenario will be if you develop a health-related condition that makes it impossible to buy life insurance at all.
That’s less likely today than ever before, since the insurance industry now provides policy options. Even for those with chronic health conditions.
But if you develop such a condition and find you either can’t qualify for coverage or can’t afford the premium, you’ll quickly realize you waited too long.
For those reasons, a strong argument can be made for purchasing a policy, even when there’s no immediate need. Or for buying a larger policy than you need right now in anticipation of higher future obligations.
That said, life insurance tends to be much less expensive when you’re young, particularly in your 20s. That would be the ideal age range to buy your policy.
I Have Life Insurance Through My Employer – Isn’t That Enough?
This is one of the biggest misconceptions when it comes to life insurance. Many people think “I have a policy at work, so I’m covered.”
But there are a few flaws in that thinking.
First, most employers provide only a limited amount of life insurance coverage to their employees.
Typically, you’re limited to no more than two or three times your annual income.
And if you also receive commission, bonus, or overtime income, the death benefit may be limited to your base income only.
True, if you’re a single person with no dependents or significant obligations, that may be enough coverage.
But the other issue with employer policies is that they expire with your employment.
Leave your job, or get fired or laid off, and you lose your life insurance as well. If that’s the only coverage you have, you’ll be completely uninsured.
You may believe that will be the time to purchase your own life insurance policy. But it may not be as easy as it seems.
If the reason for your separation from your employer is because of a layoff or firing, you may not have the income to afford to buy your own policy.
And if you have a significant health condition, you may find purchasing your own policy to be cost-prohibitive.
Employer-paid life insurance is an excellent benefit to have, no doubt. But you should view it as a supplemental policy at best. While having your own private policy.
Choosing The Best Life Insurance for Your Needs
In truth, buying life insurance is a pretty simple process. At least once you understand why you need it and how much you need.
From there, it’ll just be a matter of selecting the policy type you want, the amount you need to buy, and where you’ll buy it.
If you’re in good health, you should focus on buying the most life insurance you can afford. But if you’re not in good health, you may need to work with a life insurance broker.
A broker can place your application with life insurance companies that specialize in whatever health condition you have.
But whatever you do, be sure to get quotes on multiple policies. Never assume all insurance companies charge the same premium for a given amount of life insurance.
There can be significant differences in pricing from one company to another.
In addition, don’t buy any life insurance policy you don’t fully understand. There are plenty of those available, and most of them won’t work for you even if you do know what they’re really about.