My college roommate just started in the insurance business. He’s been aggressively pushing me to buy more life insurance. I told him that I have adequate coverage. He said I am grossly underinsured and “no one ever said on their death bed that they regret having extra life insurance.” My question is how much insurance does one actually need and what type of insurance makes the most sense? I just want to make sure I’m doing what’s right for my family without getting hustled into buying something I don’t need. Thanks. – Anonymous
Life insurance is an integral piece of the financial planning puzzle. However, since I don’t know your specific situation or current insurance coverage, I’ll answer by providing a more general overview of the life insurance landscape. Hopefully, the below framework can guide you to the correct decision.
What is life insurance? Before delving into the more involved questions about life insurance, it’s worth reviewing what it is and why it is important. Life insurance is a contract between an insurance company and a policy owner. A life insurance policy guarantees the insurer will pay a sum of money to the named beneficiaries when the insured person dies in exchange for premiums paid by the policyholder during their lifetime. This is a way to ensure that if someone were to pass away, those who depend on their income (e.g. spouse or children) will receive a sum of money to provide for them financially. I’m certain that any family with young kids can appreciate the importance of obtaining proper life insurance coverage to protect their family’s ability to maintain their lifestyle and pay their bills in the event of a family breadwinner’s untimely passing.
How much life insurance does one need? In order to determine how much coverage you need, it’s important to do a needs analysis. That is just a fancy way of saying that you need to determine how much money your family requires to pay their annual expenses for a predetermined number of years. Major expenses that should be considered include a mortgage, utilities, yeshiva tuition, and food. It’s important to factor in that some of these expenses, like a mortgage and yeshiva tuition, will go away over time. Additionally, the analysis should consider your various streams of income, other assets, and existing insurance coverage. Remember, the purpose of life insurance is not to enrich your family. Rather, it’s to ensure that loved ones can maintain their lifestyle after a breadwinner’s death.
There may be an instance where a family doesn’t actually need life insurance at all. If a family has adequate liquid assets to meet their living expenses for a multi-decade time horizon, then insurance may not be needed. This may not be a common scenario, but it’s worth pointing out that buying life insurance is not a forgone conclusion for every family.
It’s also worth noting that there are various creative uses for life insurance, as well. Some examples include business succession planning, charitable giving, estate planning, providing liquidity to a deceased person’s estate, and a hybrid policy that includes long-term care coverage. For the purposes of this article, we will focus primarily on the typical family’s life insurance considerations. These other more sophisticated strategies that apply to a smaller portion of the population and require a more in-depth discussion.
Finding a suitable life insurance policy: Once you determine how much coverage you need, it’s time to find a policy that fits your needs. The question usually boils down to choosing between term and permanent life insurance. As the name suggests, a term policy will provide coverage for a set term of years. When that term is up, coverage stops and a death benefit would no longer be paid out. People often choose a term that will lapse once major expenses, like a mortgage and yeshiva tuition, are behind them and their kids are old enough to be self-sufficient. The thinking behind this strategy is that at that point insurance proceeds wouldn’t be needed to cover expenses. The premiums associated with this type of policy can be structured to be the same, or level, for the entire life of the insurance policy. Premiums on a level term insurance policy will almost always be much lower than most permanent insurance policies, which may be helpful from a cash flow perspective.
The other type of insurance is permanent, which refers to life insurance policies that do not expire. The two primary types of permanent life insurance are whole life and universal life, with universal life offering more flexibility on payments and features. Most permanent life insurance combines a death benefit with a savings portion. The creative uses for life insurance that I mentioned in the previous section may necessitate permanent life insurance. However, if you don’t have one of those needs and you determine that insurance coverage really isn’t required for the rest of your life, then term insurance is likely the better solution for your family given its significantly lower premiums.
There are a myriad of excellent life insurance companies, so don’t feel limited to one provider. It’s important to have your insurance professional shop the market for the most competitive pricing on the most appropriate policy.
When you should be skeptical: Some of the biggest challenges with the life insurance buying process is with how these products get sold. If you can navigate the landscape knowledgeably and avoid the unscrupulous salesperson looking for a quick commission, it will save you a lot of money and hardship later. These are some things to look out for:
Overly complicated products: At its heart, life insurance is an easy-to-understand product that provides for a specific need. If an insurance agent is offering you solutions that seem too complicated, have too many moving parts, and a variety of features, then trust your gut and find something simpler or work with another agent. Obtaining proper life insurance should not be overly complicated or difficult to understand.
Insurance pitched as an investment: I said it above, and I’ll say it again, the ultimate purpose of insurance is to provide financially for one’s loved ones in the event of the breadwinner’s untimely passing. Investing within a life insurance policy is extremely expensive and inefficient. A diversified portfolio of low-cost mutual funds of your choosing is far cheaper. Additionally, tax-deferred growth can seamlessly be achieved through maximizing contributions to a retirement plan, IRA, health savings accounts, and 529 plans. If you have more money left over after that, then open a brokerage account. You won’t owe tax unless you made money on your investments through dividends or capital gains.
Borrowing against policy: If someone borrows against their insurance policy, any remaining loan balance would be subtracted from the death benefit when they pass, which may cost their family the coverage they need. Additionally, it may take many years before there is adequate cash value built up in the policy to be able to borrow again. Plus, the interest rate on these life insurance loans may be less competitive than a regular bank. In short, traditional financing options are likely a much better option if needed.
Insurance professionals who only sell their companies’ products: You should work with an agent that can price out the entire market. There are many great products available with highly ranked insurers. Don’t let your insurance agent’s sales quota limit your ability to find the most competitively priced product.
Overly aggressive salespeople: Any salesman who claims that insurance is the solution to all your financial needs is either uninformed, brainwashed, or both. There are plenty of high caliber insurance professionals out there. The best ones first take the time to understand your full financial picture so they can engage in a knowledgeable discussion about where insurance may fit into your life. Anyone who doesn’t take the time to understand your individual situation before trying to sell you a product should be avoided.
When it comes to life insurance, the key is to evaluate your own needs and use the above framework to determine what is required to protect your family. If your friend keeps pressuring you to purchase unnecessary life insurance coverage, you need to be firm in your response when telling him you won’t be working together. This direct response may seem uncomfortable, but so is getting aggressively solicited for a product that you don’t need. One tough conversation may save hours of pointless and frustrating conversations in the future.