Life insurance is a simple product
Life insurance is a simple product. It pays out if you die. If you don’t die and continue to pay the premiums your insurance provides financial security for your family.
There are variations when you get into universal-life and whole-life insurance, but term insurance is all that most people need.
Still, many people don’t understand life insurance. Perhaps that’s the reason that so many have no insurance, inappropriate amounts (too much or too little) or the wrong kind of insurance for their needs. That, plus the fact that they may not know where to buy insurance.
In his fine book, The Facts of Life: How to Build Wealth and Protect Your Assets with Life Insurance, Paul Grimes makes the point that a better, more accurate name for the product would be standard-of-living insurance.
“That’s because it’s designed to help your beneficiaries (presumably, your family) maintain their standard of living even after your death,” Grimes writes. “Will your death – more specifically, the loss of your income – jeopardize your family’s standard of living?”
Imagine that you’re a 40-year-old man earning a six-figure income whose wife has been home for years raising three children. She could return to work, but her job skills are lacking and her income would be low. Plus, then there would be child-care costs. Oh, then there is that small matter of a $200,000 mortgage and a car loan.
Clearly, there is a need for insurance to protect your family from financial ruin. Don’t forget insurance on your spouse. She has no income but if something happened to her you’d have to deal with child care, at the very least.
How much insurance do you need? Some advisors recommend five to 10 times your annual income, but that’s an overly simplistic way of looking at it and doesn’t account for the need for insurance on a no-income spouse.
Related article: How much life insurance do you need?
Grimes points out that there are many online needs-analysis tools. That’s a better way than using some income multiplier, but you’ll need to buy the insurance somewhere anyway and you’re best off with an independent broker with access to products from many different insurers. Have the broker do a proper needs analysis.
A do-it-yourself needs analysis will likely be wrong – you’ll probably miss something or incorrectly input some of the information. Perhaps your error will be small and you’re slightly under insured. No big deal, perhaps. However, your error could leave you under insured by a couple hundred grand. Big deal!
Unless you need life insurance for only a few years, consider a 20-year term policy, which costs less than two 10-year terms. Your broker can be helpful in analyzing the options.
Related article: What type of life insurance should you buy?
Grimes discusses mortgage insurance. It’s a poor product pushed by banks and other lenders. You’re much better off building mortgage insurance into your personal insurance plan.
Related article: Do your homework before you buy life insurance
Be sure to also consider disability insurance. That’s another topic, except to say that disability insurance is often more important than life insurance. Usually, the risk of a disability that prevents you from working for months or years is far greater than your risk of death.
That means that disability-insurance costs are significantly higher than those of life insurance, but the financial risk of a disability that may prevent you from working for three or four years (or longer) can crush your finances, including the retirement savings that you’ve accumulated over many years.
Related article: Understanding disability insurance
Paul Grimes does a great job of explaining life insurance concepts. Get the book and read it. If you have adult children, pass it along to them.