This question has likely crossed your mind at least once.
By having life insurance in place, you can reduce the financial distress on your loved ones during an already stressful time.
In this episode, Jeremy Keil speaks with Mike Smith, president, and owner of CPS Horizon Financial. Mike helps you determine the ideal life insurance policy for your family, with an insightful discussion on the length of policy, coverage, policy types, and how to find the right insurance agent.
Mike discusses:
- Key questions to ask before buying life insurance
- How independent insurance agents differ from captive agents
- Why every policy holder should regularly review their “in force illustration”
- The importance of living benefits — and why they are gaining popularity
- And more
3 Things You Need To Know Before Buying Life Insurance
1. Ask These Key Questions Before Buying Life Insurance
If you’re thinking about getting life insurance but are not sure where to begin, start by asking the following three questions:
Do you need life insurance?
If you are a single individual with zero debts and no dependents, you might not need life insurance.
But once you reach a stage in life when someone is dependent on you, such as a spouse or kids, you should consider getting life insurance.
You can think of life insurance as a replacement for your income when you’re no longer around to support your loved ones. Replacing income is incredibly important, whether you’re in your thirties or about to retire.
Although retirees don’t have a salary to replace, they might need to replace income from their pension or Social Security.
Discussing your life insurance needs with your financial advisor can help determine the answer to this question.
How long do you need the insurance coverage for?
Next, you need to decide the required length of your insurance coverage, which depends on your financial needs.
For example, if you have a 2-year-old child, you might need coverage until he or she is old enough to move out of the house. In this situation, a 20-year term policy might be all you need.
Another key factor to consider is a mortgage. You might need a policy long enough to cover your mortgage payments.
If you’re worried about outliving your term life insurance, you can also get permanent insurance. (We’ll discuss the different types of life insurance later in this blog.)
What amount of coverage do you need?
There is something called a “financial needs analysis” that your financial advisor can help you with. It is a way to calculate your ideal coverage amount.
However, if you just want a quick estimate of your required coverage, use this rubric:
Coverage = One-time debts + (income to be replaced x number of years)
In the above formula, the one-time debts can include your mortgage, estimated college debt for kids, and other major debts you want to be paid off.
Then, you add the amount of income you want to replace multiplied by the number of years you want to replace it for.
Another quick estimate for your coverage is simply 12-15 times your current income.
2. Find the Right Insurance Agent
There are two types of insurance agents that you should know about — independent agents and captive agents.
A captive agent works for a particular insurance company and primarily sells policies offered by that company. Even if they represent other companies as well, they might offer those policies to you first where there are financial incentives for them.
An independent agent has the ability to look at a pool of several insurance companies and shop for the best policy for you. They are likely to have more options compared to a captive agent.
CPS Horizon Financial is a great resource where you or your financial advisor can search through a vast product mix, including insurances offered by several companies.
3. Understand the Different Types of Insurance
There are two basic types of insurances — term insurance and permanent insurance.
Term insurance is the cheapest type of life insurance. You can buy the policy for a specified time, such as 10 years, 20 years, or even 40 years with some companies. If it is a level term insurance, the premium remains the same for every year.
For permanent insurance, let’s take a look at the two most popular options — whole life and universal life.
Whole life is the most expensive type of insurance. It includes a pure cost of insurance, which increases every year. Remember, this is not the same as premiums, which are much higher than the pure cost.
The excess (difference between premiums and pure cost) goes into building up cash value, similar to a savings account which you can tap into down the line.
Universal life is a blend of term and whole life insurance. It offers more flexibility around premiums and a lower pure cost of insurance.
However, it’s important to monitor a universal life insurance policy regularly. The originally scheduled premium amount may not have kept up with the cost of insurance, or the decrease in interest rates over the past 40 years. Because of that, the scheduled premiums and the existing cash value may no longer be sufficient to keep the policy active!
To keep a better track of how your universal life policy is performing, ask for an in force illustration from your insurance company. It can help you project how your policy will perform based on different premiums. It’s good practice to take a look at your in force illustration at least once every four years. You can also discuss it with your advisor.
Bonus Idea: Consider Adding Living Benefits
Living benefits are extra benefits that could be added to a life insurance policy. They allow the insured to access the death benefit of the life insurance while they’re alive if they need the money.
There are multiple types of living benefits. Some commonly used ones include Chronic Illness Riders, Critical Illness Riders, and Long-Term Care Riders.
As their names suggest, they allow you to access the death benefit in case of a long-term illness or disability, a major health condition, or when you need to pay for long-term care.
Although they may require increased premiums, they can be highly beneficial when you need to urgently access your death benefit while you’re still alive!