Life Insurance

How Much Life Insurance Do I Need?

There is no precise formula to tell you how much insurance coverage you need. Some consumer groups recommend five times your gross annual income. Under this formula, a family with an income of $40,000 might need at least $200,000 worth of life insurance protection ( face value of the policy).

Some insurance industry organizations recommend a policy paying ten times your gross yearly income. With this formula, the family mentioned above would need $400,000 worth of insurance.

Before buying life insurance, assemble your personal financial information and review your needs. You should consider:
  • Immediate needs at the time of death, such as final illness expenses, burial costs, and estate taxes.
  • Funds for a readjustment period, to finance a move or to provide time for remaining family members to find jobs or better-paying jobs.
  • Ongoing financial needs such as monthly bills and expenses, outstanding debts, day-care costs, college tuition, support for elderly parents, and retirement.
You also need to take into account any assets you have, such as cash; savings; Social Security and pension benefits; other insurance, including mortgage insurance; and, real estate. Some of these assets will be available for immediate use, some to finance a readjustment period, and others may help your family meet long-term, continuing needs.

What Kind of Life Insurance Should I Buy?

Not all life insurance policies are the same. There are four basic types of life insurance: Term Life Insurance, Whole Life Insurance, Universal Life Insurance, and Variable Life Insurance.

Term Life Insurance

Term Life Insurance policies provide a check to your beneficiary when you die. Term Life Insurance policies generally are cheaper and easier to understand than other kinds of life insurance policies. Term Life Insurance usually offers you the best value for your money by giving you the biggest death benefit for your premium dollar.

Term Life Insurance covers you for a term of one or more years. It pays a death benefit only if you die in that term.

You can renew most Term Life Insurance policies for one or more terms even if your health has changed, although you may be required to complete a medical questionnaire and might be refused insurance if your health is poor. But each time you renew the policy for a new term, premiums may be higher because you will be older. If you are thinking of buying Term Life Insurance, make sure you can afford the premiums for as long as you want to keep the policy. You should ask the company to show you how you could expect premiums to increase over a 10-year or 20-year period.

To avoid yearly increases, you may want to look for 5, 10, 20, or even 30-year renewable Term Life Insurance policies where the premiums will stay the same for those periods. These long-term policies may "lock in" premiums for as long as you need a high level of insurance, e.g., until your mortgage is paid or your children graduate from college.

Most Term Life Insurance policies are convertible. You can exchange your Term Life Insurance policy for a Whole Life or other type of insurance policy without taking a medical exam or answering any health questions. You may decide to convert your Term Life Insurance policy if your health declines; it may be difficult for you to qualify for a new Term Life Insurance policy at affordable rates. Conversion is usually allowed until age 65.

Whole Life Insurance, Universal Life Insurance, and Variable Life Insurance

All of these types of insurance differ from Term Life Insurance in one way: once you have paid your premiums for a number of years, the policy will have a cash value attached to it. But, if you withdraw all or part of the cash value, the amount of money you receive usually has substantial surrender charges already taken out of the amount you will get. The amount you may expect to receive when you terminate the policy is called the cash surrender value. You may need to pay taxes on the cash surrender value when it is paid out to you.

If you buy a cash surrender value policy, be sure you will be able to keep up premium payments for at least fifteen to twenty years. If you cash the policy in before that time, the surrender charges and other expenses might leave you little actual cash surrender value remaining.

Agent commissions on cash surrender value policies are several times higher than those on Term Life Insurance policies. Keep this in mind if an agent continues to recommend a Whole Life Insurance policy when you ask about Term Life Insurance.

The insurance company will lend you money against the cash surrender value of your policy, or you may use your cash surrender value as collateral for a bank loan. If the loan is with the insurance company, you may have the option of paying the loan interest from any value that is left or future dividends that you earn. But, if there is not enough left in your account to support at least those payments, you are in danger of losing the policy altogether . Plus, if you die and the loan has not been repaid, the insurance company will deduct the amount owed plus interest from the money paid to your beneficiary.

In recent years, some consumers were encouraged to make a loan against the cash surrender value or to use dividends from insurance policies they already owned to buy a new or additional policy. Some consumers found they had taken too much in loans. They lost the first policy and then couldn't afford the second policy.

Even if you are in no danger of losing one or both policies, these kinds of transactions are not generally in your best interest.

Whole Life Insurance

Whole Life Insurance may be called straight life, ordinary life, or permanent insurance. Whole Life Insurance covers you for as long as you live, as long as you pay the premiums. There is no need to renew Whole Life policies.

In order to buy Whole Life Insurance you will usually have to fill out a health questionnaire, and you may need to have a medical exam. Depending on the medical information you provide, your premiums may be higher than the standard rate, or the insurance company may decide not to offer you a life insurance policy.

It is important to be very honest about any medical conditions which could affect your life insurance. Your beneficiaries might receive no benefit at all if you die within two years of buying the policy and you have not told the truth about a situation or medical condition which would have caused the company to deny you insurance if they had known the truth.

With a Whole Life Insurance policy, you generally pay the same amount in premiums for as long as you live. This premium is based on your age and your health at the time of purchase. In some cases, the premium you pay may change over time, but you would be shown this when you first buy the policy. Be sure you understand what your premium payments will be and that you can afford them over time.

In the early years of the policy, premiums for Whole Life Insurance may be much higher than you would pay for the same amount of Term Life Insurance. But remember, the premiums in most term policies will rise each time you renew.

Many Whole Life Insurance policies also earn dividends, usually on an annual basis. If you do not take the dividends out when they are earned, but instead leave them on account with the insurance company, the dividends will also earn interest.

If a company pays dividends, it may pay more or less in dividends than it had been paying when you bought the policy. The dividends a company will pay depend on many factors, including the performance of their own investments and the efficiency of their operations. The company's earnings and expenses can fluctuate just like the stock market. When you are choosing an insurance company that pays dividends, ask for a company's history of projected dividends versus paid dividends. Remember that dividends are not guaranteed and may differ from those shown in sales illustrations.

Sometimes, dividends may be used to purchase Paid-Up Additions (PUA's) to your policy, an increase to the death benefit. Some companies will use the dividends on your policy to buy additional Term Life Insurance. But, you might have less insurance than you planned if the dividends go down and these additions did not supplement your benefits.

In recent years, many consumers were told that dividends their policies earned, and the interest on those dividends might, or would, become large enough to pay the premium payments. (This is sometimes called " abbreviated payment ," or " vanishing premium .") But, often this didn't happen and those consumers were stuck paying for insurance they couldn't afford. Or, they lost their insurance plus all the money they had paid in.

If you decide to buy a policy which has an abbreviated payment or vanishing premium option, you should keep close track of your policy's earnings. Changes in interest rates, cost of insurance, policy expenses and loans can quickly eliminate your policy's ability to pay for itself. Even if you can stop paying premiums at some point, you might have to start paying again at some later point.

Unless the insurance company guarantees in writing that you will no longer have to pay premiums after a certain time, you should assume you will have to continue to pay.

Universal Life Insurance

Universal Life Insurance, also referred to as Flexible Premium Universal Life, lets you vary your premium payments and when you will pay the premiums, with some limits on how flexible you can be. For example, you may be able to skip a premium payment; or, increase or decrease your premium payments as long as the total amount of premiums you are paying in over a period of time is enough to keep the policy in force. As you get older, however, the minimum premium payments may increase.

Cash surrender value for a Universal Life Insurance policy depends on the performance of the insurance company's investments. Make sure you understand whether any benefits or cash surrender values are guaranteed. Even if there is enough in your account to pay the premiums, continuing to pay premiums yourself means you build up more cash surrender value.

If you do not pay enough in premiums, you may reach the point where your insurance coverage will end. To prevent that, you may need to raise your premium payments or lower your death benefits. The insurance company must send you an annual report and will also notify you if you are in danger of losing your policy due to insufficient value.

When you buy Universal Life Insurance, you may be able to change the amount of the death benefit (also called the "face amount"), after you buy the insurance. But, to increase the death benefit, you may need to fill out another health history or have a new medical exam.

Variable Life Insurance

Variable Life Insurance benefits (both the death benefit and earnings) vary based on the investment performance of the assets in which your premium payments are invested. You will generally be offered a variety of investment options (equity, bond, and money market mutual funds). Death benefits and cash values are directly related to the performance of investment options you choose. There may be a guaranteed minimum death benefit; however, you may be required to pay extra for that feature.

There are two kinds of Variable Life Insurance policies. You can buy a policy which has premiums with set times and amounts, or you can buy a policy which allows changes in premium payment times and amounts. Unlike Universal Life Insurance, however, the death benefit will also change depending on how much you pay in and the performance of the investments you choose.

The insurance company will give you a "prospectus" which will explain the policy before you buy it. The company will probably describe the different investment options in the prospectus, but you may also ask for additional information about the investment options. Study the prospectus carefully and be sure to ask the company about anything you don't understand.

Agents who sell Variable Life Insurance must have both a Massachusetts insurance agent license and be registered as representatives of a broker-dealer licensed by the National Association of Securities Dealers (NASD) and be registered with the Securities and Exchange Commission (SEC) as well. The SEC also reviews and approves the contents of the prospectus you will receive, and is currently involved in an effort to make these prospectuses much more understandable to consumers.

With a Variable Life Insurance policy, there are usually no guarantees. If the investments you choose lose money, you could find that the value of your account is far less than the amounts you have paid in.

Although some Variable Life policies may include a minimum guaranteed death benefit, others do not have this guarantee. It is possible that, if you were to die when the values were low, the death benefit your beneficiaries received would be reduced to little or nothing.

Comparing Major Types of Life Insurance

Term Life Whole Life Universal Life Variable Life
Premium Lower initially.
Increases with each renewal.
Higher initially than Term Life Insurance. Normally doesn't increase.Flexible premiums.
Premiums can rise as you get older or if the company's investments do not do well.
Fixed or flexible premiums.
Protects for A specified period.Entire life if you keep the policy.Entire life if you keep the policy.Entire life if you keep the policy.
Policy benefits Death benefits only, no cash surrender value.Death benefits, possible dividends, and eventually a cash surrender value.Flexible death benefits and eventually a cash surrender value.Death benefits, earnings, and cash surrender values vary in relation to the performance of the investments you choose.
Advantages to Buyer Lower initial outlay. At first, may be able to buy more insurance for less cost.Fixed premium amount.
Can take a loan against policy, or surrender policy for some cash.
More flexibility.
Takes advantage of current interest rates.
You can choose to invest your money in stocks, bonds, money market or other accounts.
Disadvantages to Buyer Premium increases each time a new term starts. The insurance company is free to substantially raise premiums if your health changes.Dividends can be hurt by low interest rates. You will lose money if you cash it in. Usually no cash surrender value for at least 3-5 years.Same as Whole Life Insurance and you assume greater risks due to program flexibility.Same as Whole Life Insurance and you bear all the investment risk.
Options May be renewable and/or convertible to a whole life policy.Partial cash surrenders may be permitted.Minimum death benefit.
Partial cash surrenders permitted.
May offer a guaranteed minimum death benefit.

How Much Will Life Insurance Cost?

Different insurance companies charge different rates for their life insurance. Comparing costs can be very difficult. For example, one company might offer a competitively priced policy for 25-year-olds, but not for 40-year-olds.

There are some common factors that insurance companies use to decide how much to charge you for the kind and amount of insurance you want to buy. These include:
  • your age and gender;
  • your health and health habits (such as smoking);
  • your family health history;
  • whether you are engaged in a hazardous occupation, or have dangerous hobbies (such as auto racing or sky diving).
The insurance company will get this information from your application, and may ask you to fill out a health questionnaire, or have a medical examination. Once they have the information, the insurance company will decide if your risk of death is average or greater than normal for your age and gender. If they believe the risk is greater, they will charge you more than normal. (This is called being rated.) Remember, a different company may not believe your risk is greater than normal, and may charge you their standard rates.

If you are "rated," you should be told the reason, such as poor health or a dangerous occupation. If the reasons for the original rating improve, tell your insurance company and ask them to review the situation. Your premiums might go down.

Another major difference in determining insurance costs will be the insurance company's administrative fees and expenses, including overhead, agent commissions and other costs of doing business.

What Other Benefits Are Available in Life Insurance? ("Riders")

At the time you buy a life insurance policy, you may want to buy additional benefits. These benefits are called riders. If you buy riders, you can expect to pay more than if you bought simply the basic life insurance policy. Here are some common riders, but you should ask the insurance company what riders are available with the policy you are thinking of buying.

Accelerated Death Benefits

These are also known as "living benefits". You may receive all or a part of the benefits of your life insurance policy before you die. Living benefits are paid out for causes such as: terminal illnesses like AIDS, organ transplant, or permanent confinement to a nursing home. The allowable reasons to receive living benefits may be different for each company, and you should check before you buy the policy. Any benefit paid to you before you die will mean that your beneficiaries will get that much less when you die.

Viatical Settlements

A "viatical settlement" is not insurance. It is a contract in which the terminally-ill owner of life insurance (the "viator") sells the death benefit to a third party in return for immediate cash. This cash will be a percentage of the expected death benefit. For example, the viatical settlement company buys a life insurance policy that will pay a $100,000 death benefit, for $80,000.

If you sell your life insurance to a viatical company in a viatical settlement, that company will pay future premiums and will be the owner and beneficiary of your life insurance. Once you die, your original beneficiaries will get nothing from that life insurance policy.

The viator may also contract for a "viatical loan" with a viatical loan company. In this instance, the loan is secured by the value of the life insurance policy. You will be expected to make regular payments on the loan and continue to pay your life insurance premiums, but you will retain ownership of the life insurance policy.

The percentage you can expect to receive from selling your policy, or the amount and terms of the loan may vary widely from one viatical company to another. You should seek offers from several companies in order to get the best result.

In determining the sales price or loan amount, the viatical settlement or loan company considers several factors, including the life expectancy of the person whose life is insured. The shorter the life expectancy, the higher the payment.

Payments generally vary between 50 to 90 percent of the policy's expected death benefit, but can be even less than 50 percent of the expected death benefit.

If you are considering a viatical contract you may want to consult with your lawyer, doctor, life insurance agent or company, and accountant or financial planner. These contracts are very complicated, and may affect other issues such as Medicaid eligibility. You may not be able to back out of a viatical contract once you have signed it, so you will need to be very certain of what you want to do before you sign.

Accidental Death Benefits

Also known as a "double indemnity", this rider pays an additional amount if death is accidental. In some cases, policies may pay up to three times the normal death benefit should death occur by a specific type of travel accident, such as an airplane crash.

Automatic Premium Loan

If you do not pay your premiums, the insurance company will automatically make a loan against your policy to cover the cost of the premiums. This rider can be used only if your life insurance policy has sufficient cash surrender value.

Guaranteed Insurability

A Guaranteed Insurability Rider would allow you to buy additional life insurance at specific times without having to answer any questions about your health. However, the cost for the new policy would still be based on your age at the time you buy it.

Premium Waiver Provision

This is a rider which takes effect if you become disabled. The disabled person will not have to pay premiums for the duration of the disability, even if it is a lifelong disability. In cases where the policy owner is not the person insured, e.g., a parent who is paying for life insurance for a child, this provision takes effect if the policy owner (in this example, the parent) becomes disabled. You are responsible for notifying the insurance company if you become disabled.

Life Insurance Q & A

Q. Where can I buy a life insurance policy?

A. Individual life insurance can be purchased directly from an insurance company, through the mail or from an insurance agent. Insurance may also be offered over the Internet, but you will usually have to sign a paper application as well. Group life insurance may be available through your job or through a group to which you belong.

Most life insurance agents and brokers are honest; they sincerely want to help you meet your insurance needs. However, many consumer complaints are from people who had "complete faith in my agent," or "never doubted my broker because he was referred to me by a member of my family". A good agent or broker will work hard to make sure you really understand what you are buying, and will not be impatient when you ask to "see it in writing".

An independent financial planner or accountant can help you clarify your financial needs and review insurance proposals you are considering. A professional who does not work for the insurance company that wants to sell you insurance can provide an unbiased opinion on what is available.

Q. Do I have time to think about my purchase?

A. Make sure you understand the policy before you buy it. But, you will also have at least ten days after the policy is delivered to you to return the policy. This is called a free look period. If you do this within ten days, the company will return all of the premiums you have paid.

Q. How can I buy the most insurance for the least cost?

A. Term Life Insurance usually gives you the most insurance for the least amount of money. Also, you may save money by buying a policy with low administrative fees. These "low- load" policies are sold primarily by a handful of insurers through direct mail or toll-free telephone numbers. Low-load policies also may be sold by financial planners licensed as insurance counselors who charge a service fee rather than a commission. Since the initial fees are low, low-load policies also cut your risk of losing money if you surrender your policy early.

Q. How else can I save money on life insurance?

A. Group policies, available through employers, are often cheaper than individual ones. You usually don't have to take a medical exam, nor do you have to answer health questions to qualify. In some group insurance, for example insurance available through your work, you may have to show that you have good health if you apply for the insurance later than 60 or 90 days after you were hired. Group insurance also may be available through professional, civic or religious associations.

Group life insurance may be offered at a single rate per person, or there may be only a few categories, such as age and gender. This is particularly true if the insurance is Term Life Insurance.

Q. Will I need life insurance when I retire?

A. It depends on your individual financial circumstances. Social Security and some retirement plans available through employment cover burial costs and may provide a continuing income for dependents after a retiree's death. Some consumers are able to use the accelerated death benefit rider available in some life insurance policies to cover nursing home costs, but this will usually not provide the same amount of protection as long-term care insurance.

Q. Can a company refuse to pay a claim in case of suicide or if I do not tell the truth on the application or in the medical exam?

A. In the first two years after you buy a policy, the company can refuse to pay if the cause of death is suicide, or if you have made a material misrepresentation in the application. A " material misrepresentation" happens if you do not tell the truth about a situation or medical condition which would have caused the company to deny you insurance if they had known the truth. If you understate your age to obtain a more favorable premium, the insurance company will reduce the death benefit to be equal to what your premiums would have purchased at the correct age.

After the policy has been in force for two years, the company cannot contest the claim as long as you have paid the premiums. This is called incontestability. If you change companies or policies, you may be required to go through another two year period in which the company could deny a claim because of suicide or a material misrepresentation in the application.

Q. What happens if I miss a premium payment?

A. During the grace period, the 30-day period after the date your premium is due, you can pay your premium with no interest charged. If you die during the grace period, your beneficiaries would receive the death benefit of the policy minus the premium owed.

If you do not pay the premium within the grace period, your policy will lapse. That means that you have ended your relationship with that insurer and, if you were to die, your beneficiaries would not get any death benefits. Most companies will allow you to reinstate a lapsed policy for up to three years. To reinstate a lapsed policy, you would have to pay all overdue premiums with interest, plus reinstate or repay any loans you have taken against the policy. You might also be required to fill out a new health questionnaire or have a medical exam.

Part Three