MythTip: Buying Life Insurance
Why Life Insurance?
Firstly, be aware that life insurance is something that you buy without the intention to ever use it. If you buy a policy on yourself, do you really want to cash it out? The second thing to remember is that life insurance is something that you purchase for others. It is not something you get for yourself. If your life insurance policy is paying out, then you are not going to be around to get the benefit. The last basic principle is that having your policy pay out the benefit is NOT winning against the insurance company. Some people feel that they don’t want to pay for something that is never going to pay out. They get into a competition with the insurance company. They feel that somehow they have to get some cash out of the insurance company in order to come out ahead.
But the thing to remember is that life insurance IS insurance. Like rent, insurance is something that you pay for that gives you something in return, but not necessarily cash. When you buy insurance, you are buying protection. In the case of life insurance, you are buying protection for your loved ones in the event that you should die. So just remember, not ever using your life insurance policy means that you WIN, not that you lose. It means you get to live, and I call that a victory.
You should buy life insurance to help those who depend on you for financial support. Should you die, they will need the benefit from the insurance to help them to subsist while they get back on their feet. Life insurance can be used to pay off significant debts, provide a college fund for children, and to supplement survivor’s income.
When Should I Buy?
Since life insurance is something that you buy to protect your dependents, you don’t really need life insurance if you have no dependents. Who are your dependents? A spouse whose income cannot meet the family’s needs, children, perhaps siblings with disabilities, sometimes even parents who rely on your income to help support them. Basically, it is anybody who depends on your income. So, for some people, no life insurance is needed.
There is, however, at least one reason to buy insurance even when you don’t need it. Insurance rates are cheaper the less likely you are to die. That means that the younger you are, the cheaper the life insurance is. Many types of life insurance allow you to lock in your rates when the policy is first formed. If you buy young, you may be able to lock in a low rate for your entire life.
How Much Life Insurance Should I Buy?
This question is impossible to answer for everyone at once. Perhaps more so than any other financial question, this one requires a close look at your precise situation. But here are a few guidelines to help you get started.
- Cover your debts. You want your dependents to be able to keep all of their possessions without having to worry about losing it to the bank. You will want to pay off the mortgage on your home so that your family can have a place to live without the stress of a mortgage. You may also want to repay car loans, student loans, etc.
- Provide a college fund. This is more optional than covering debts. You will need enough coverage to provide for the funds to be invested to grow until they are needed. This is a complex calculation because the inflating cost of college must be calculated across every year the child will be in college for each child, and the amount you need to invest needs to grow at a certain rate to provide the right amounts of money at the right time.
- Supplemental income. In order to help replace the value of your work experience, the interest that your funds earn can become supplemental income to your family. Another thing to consider is the possibility of increased living expenses for your family after your death. A big one would be day care. If you have small children, your spouse (now widowed) would have to work to support the family, which means that they would not be able to stay home with the children. The cost of day care can be huge, and your life insurance can help offset that cost, or pay for it outright. There are other possible expenses. Perhaps the family may need a family therapist to help them cope with their loss, perhaps you die in a car accident and now the family needs a new car. There may be medical bills if others were in the car, or there may be your own medical expenses to cover. These are all things to be aware of.
Knowing your basic sources of life insurance needs is where you need to start. Each of these life insurance needs need to be discounted and applied within financial calculations in order to ensure that you have the correct amount that your loved ones will need. These calculations are tough, and require a careful analysis. You want to be careful not to purchase too much life insurance because the more you buy, the more it costs. I recommend consulting a financial planner (NOT an insurance salesman) to determine your exact life insurance needs. To aid you in your quest, you will find a new calculator on the downloads page that can help you get a rough estimate of your life insurance needs.
Posted on 2 Jan 2009