One of the most consequential financial decisions you can make early in your tenure as a real-life grown-up has nothing to do with investing or savings or career decisions. It’s taking out life insurance. Not the most riveting topic. If the life-insurance industry practised honesty in advertising, its motto would be: It’s dull! It’s moderately expensive! It’s morbid! But just because something’s boring doesn’t mean it’s not worth doing — unless you don’t mind the thought of people you love living under a bridge, huddled around a barrel fire, cursing your name after you’re gone. To prevent that, we put together this little primer.
How do I know if I need life insurance? If you have children or a spouse or anyone who depends on you financially, then life insurance is almost certainly a good idea. That’s especially true if you have debts that those nice people would be responsible for paying. And doubly especially true if you don’t have enough cash in the bank to keep doing your part to provide for your loved ones in perpetuity.
What if I’m covered through my work? It might not be enough.
How much is enough? To get a ballpark figure, multiply your annual income by 15. So if you pull in $100,000 a year, you’ll probably need at least $1.5 million in coverage. A better way to arrive at a number is the DIME formula, an acronym for “Debts, Income, Mortgage, and Education.” Add your debt; your annual income multiplied by the number of years your family will need it; the balance of your mortgage; and, finally, education costs for your kiddos.
Sound complicated? There are online calculators that will help you crunch the numbers.
Is there a certain kind of insurance I need to get? For most people, the answer is something called term life. You pay a fixed premium every month, or maybe every year, for a set amount of time — typically 10, 20, or 30 years. And if, God forbid, you should pass away within that window, the insurer pays a predetermined amount of money to your beneficiary (i.e., your spouse or loved ones). If you’re alive and well at the end of the term, the insurance company keeps the money.
People like term life because a policy usually doesn’t cost an exorbitant amount if you’re reasonably young and healthy when you take it out, and it gives you peace of mind during the time when you need it most — that is, when you’re in your prime working years and your family is growing.
You said for most people. What are the other options? The other major category is called permanent insurance. There are different types — universal life, whole life, etc. The biggest difference between these policies and term life is that they typically remain in effect for as long as you pay your premiums. In other words, there’s no set window of coverage, which means beneficiaries can get a big payout even if you make it all the way to great-great-grandparent status. Many permanent life policies also have a cash-value. It’s less than what you’ve paid in premiums, but if you cancel the policy, you get that money back. You can also borrow against or withdraw from your cash value while you’re still alive.
That sounds so much better. Why wouldn’t we all get permanent insurance? Because it’s a ton more expensive. Like 10 or even 20 times more expensive. And the older you get, the fewer people rely on you for financial support. That’s why, for those who do get permanent insurance, it often serves as more of an investment strategy. You’re saving money that you can borrow against, and any earnings you get on your cash value, which can include interest or dividends, are typically tax-exempt. And at the end, there’s a guaranteed return on your investment.
What should I ask brokers when calling around for quotes? For term life, be sure to ask: does the policy have guaranteed premiums? (You probably want that.) Also: is the policy renewable (i.e., you don’t have to take another medical test or reapply), and is it convertible (i.e., transferable to a permanent insurance policy)?
Do I really need a physical to make it all happen? If you’re looking for a policy for less than $1 million, maybe not. Otherwise, you’ll likely need to get a medical exam. Fortunately, some insurers will arrange to have a nurse come to your house or office to do it.
What if my spouse decides to murder me to get the cash? Sounds intriguing, but insurance policies come with a contestability period to prevent people from taking advantage of most sorts of fatal loopholes.
