Why is purchasing life insurance so confusing and complicated? For many, purchasing a life insurance policy is an important decision. It’s often the first step taken in estate planning, and it involves a complex thought process because decisions are intentionally made beyond your own life. Here are some dos and don’ts to help clarify the purchase of your next life insurance policy or to examine your existing policies when reviewing previously purchased policies.
DO: Understand the goal and purpose behind purchasing a life insurance policy. Oftentimes, a policy is purchased because an insurance agent offered it to you or it was suggested by a friend or colleague; your life insurance policy should be your decision and meet your criteria, not someone else’s. Understanding the purpose of your life insurance is really the key to making the right choice in your life insurance policy. If you already know you want to “rent” a life insurance policy for 10-20 years while your kids are young, you probably want to look for some cheap term insurance. If you reasonably expect to accumulate significant assets in your lifetime, a cheap term policy might work for a while, but it’s possibly you could run into estate planning conundrums later in life. Most of the time, people aren’t sure why they want the insurance, other than they need to protect their family against an unexpected death and loss of income. In that case, further conversations with a trusted advisor might help align your goals with the insurance to provide additional insight.
DON’T: Purchase a particular policy because someone told you it’s the best policy available; there is no such thing as the best policy. There’s not a “best insurance company” either. It’s silly to think that one insurance company could be a good fit for everyone’s insurance. If you hear “this is the best insurance company”, then typically the insurance agent selling these policies aren’t acting in your best interest, and they already know you “need” a specific kind of insurance before they even talk with you. Unfortunately, insurance agents and financial advisors have combined into a financial salesperson role, who often have one or two products to offer. These products can be fairly complicated, and oftentimes, the agents who sell them don’t have a firm understanding about these products.
DO: Understand the offerings of the insurance company. This is especially important if you aren’t completely sure of the purpose and goals you have for the insurance purchase. If you need to repurpose the insurance later in life, this might be important. For example, some insurance companies specialize in providing only term insurance. If you purchase a term insurance policy, and you want to change your policy from a term insurance plan to a permanent plan, you won’t be able to do so. For some this may not be important, but if there’s a health change or a change in the financial plan, this could be an important detail.
DON’T: Purchase a yearly renewable term product. This is a term product that bases the annual premium on a year-to-year basis, and the premium rises each year and the policy doesn’t expire. Each year the premium rises, and before you know it, the policy is completely unaffordable. This kind of life insurance isn’t much (if any) cheaper than a level term product. Insurance agents want the price of the term policy to increase, so they can sell a permanent insurance product to replace it later; it’s really a disheartening and dirty tactic. I recently completed an insurance evaluation for a client who had this kind of term insurance, sold to them by a captive insurance agent. If they switched to a level term insurance policy, they would save over $150,000 in premium over the next 20 years. The yearly renewable term prices were super expensive from a “name brand” insurance company, and the insurance agent did this client no favors with the recommendations.
DO: Shop around. An insurance company’s pricing is the same, regardless of which broker is selling the insurance, so if you like your insurance agent, and he or she shops a few different carriers, that’s great. It’s perfectly fine for an insurance agent to find out what you want in a policy, shop around, and give you a few options. Not every insurance company is a good fit for everyone.
DON’T: Purchase a life insurance policy for the cash value alone. If you purchase a policy, make sure it’s for the death benefit. Cash value can have some great uses, and it has some wonderful tax benefits, but cash value is not, and should never be the purpose of a life insurance policy. Cash value might average 3% growth on a good year after the policy has already been funded for several years. The death benefit can serve as a tool to help support retirement, philanthropic, and estate transfer goals. If you’re being told to purchase life insurance as an investment for the cash value, you should reconsider the purchase and the relationship with the advisor. Life insurance is not a good investment, but investments aren’t good life insurance either. Understand there are valid uses for both investments and life insurance, but those uses don’t often overlap.
DO: Understand that there are different types of life insurance policies available, and each type has a different purpose. There’s a lot of bias about life insurance, whether it be from the insurance agent’s bias or the media’s bias. If you’re unsure about what kind of life insurance is a good fit for you, do some research or find an advisor who is knowledgeable about the subject and can serve as an educator. Life insurance products can be quite complicated, and many insurance agents and advisors don’t fully understand most of the insurance products they recommend. Regarding the type of life insurance, I’d suspect term insurance to be a good fit with most people, but term insurance has some significant limitations, depending on what you’re trying to accomplish with the insurance. The different types of life insurance have different purposes. Before deciding on what kind of life insurance you want, you should be clear on the purpose of the life insurance. Understanding the purpose of the life insurance policy will make the decision about the type of life insurance much easier to make.
Feeling good about a financial decision is important. You are making decisions about your future and your family’s well-being, and it’s imperative to get good information. Decisions on life insurance are no exception. Like many areas of finance, details can get intricate, which can complicate the decision. There is no one-size-fits-all method regarding financial planning, and while customization can make situations difficult, it is ultimately a good thing.