Life insurance is a frequently misunderstood part of personal finance.
For many, this form of risk management should be the foundation of a pyramid of financial security. This is especially true when protecting risks while you are early in your career and family life.
But life insurance can be an annoying hassle with a lengthy list of questions and rules of thumb that aren’t specific enough to rely on personally.
According to life insurance market researcher LIMRA, one in three households would have immediate trouble paying living expenses if the primary wage earner died.
Many more households might not have immediate distress but are underinsured and would likely face hardship. Typically, those underinsured do not know if they have adequate life insurance coverage or how to buy it.
Before you consider how much you need to save to retire comfortably or pay for a child’s education, it’s important to make sure your risks are protected in case something goes wrong.
As author Nick Murray writes, “We insure against what can go wrong in order to acquire the luxury of investing for what can go right.”
Unfortunately, we all know someone who died well before their time. We’re not as invincible as we like to think.
The chances of a 45-year-old man not living another 15 years are one in 10, according to the Human Mortality Database. For a 45-year-old woman, the odds are one in 17.
GO BEYOND GROUP COVERAGE
About 37.5 million American households have no life insurance coverage. Many others have only employer-provided coverage with a nominal death benefit—i.e. $50,000, or one or two times annual salary.
In most cases, especially with people who have young families, this is not enough to provide needed financial security to those left behind.
And, if you switch employers, the coverage might not be available from your new employer. Therefore, it’s helpful to have privately purchased, non-group insurance to supplement whatever is available via the employer.
This brings people back to that dreaded point of indecision. How should you proceed when you don’t know what to buy and are concerned about being sold something you don’t need or fully understand?
There are many points to consider and the process doesn’t have to be intimidating.
Temporary “term” insurance is the least expensive and easiest to comprehend. You apply for a policy with a known period of coverage (i.e. 20 years) and a stated death benefit (i.e. $500,000).
You are categorized on a scale of risk from preferred to standard and below. Those in preferred health, who aren’t testing their human flight winged suits on the weekend, pay less. If you die before the term of your policy expires, your beneficiary receives the stated death benefit.
Permanent policies, also known as whole life, get much more complicated.
They are often sold with promising illustrations of cash value building up turning the insurance policy into a savings and investment vehicle. These policies can be expensive because you are paying to for both investment and insurance functions.
HOW MUCH IS ENOUGH?
You can start by covering your known liabilities. How much would it take to cover debts (mortgage, car payment, etc.) and keep your family stable initially?
Then you can move into valuing how much of your expected future income is necessary to insure.
If your family relies on your income for several more years, decades even, you can see how the need for life insurance grows well beyond the nominal amount provided as employee benefits.
You can get a general sense of how well you are protected by using the life insurance needs calculator at lifehappens.org.
When you have clarity about the big picture, then you can evaluate your options. You’ll know how much insurance coverage you have and how much you may need.
It might make sense to layer policies with different maturity dates so that as you pay down your mortgage and build up more financial security over time, the amount of insurance coverage in place declines.
It will also be important to evaluate need for both spouses, not just the higher wage earner in the family.
You can work with an independent insurance broker to compare many insurers. This will help you understand the range of costs across companies and provide more information than if you apply through only a captive agent of one company.
If you have a special circumstance that needs to be considered, some companies are more accommodating than others.
The process – which likely also requires a blood and urine sample as part of underwriting – might be irritating, but it’s something you might need to get right only once in your life and can bring peace of mind.
Gary Brooks is a certified financial planner and the president of BHJ Wealth Advisors, a registered investment adviser in Gig Harbor. Reach him at email@example.com.