Many Americans are still not sure if they need life insurance or who does. Though 59 percent of respondents to a survey by Value Penguin consider themselves very familiar with the purpose of life insurance, a significant 33 percent admit that they know only some of what it does.
Life insurance is an insurance policy that pays out in the event of the death of the insured person.
“When your family is already grieving your loss, life insurance can assist in alleviating some of the financial obligations they may face following your death,” says Hutch Ashoo, CEO of Pillar Wealth Management and author of Beyond Wealth: Finding the Balance Between Wealth and Happiness.
“Your loved ones may need to spend funds from your estate or liquidate other assets to cover debts, leaving less money for other expenses,” says Ashoo. “Life insurance can assist your family members in repaying any debt you leave behind, such as credit card debt, company debt, personal and school debts, and home debt.”
But, given the limited knowledge that so many individuals have about this type of insurance, how are you supposed to know what is best for you and your family?
Here are the top 10 mistakes to avoid when considering a life insurance policy:
1. Not Tying Purpose to Policy
Before you start seeking out a policy, consider the reason that you feel the need to take out life insurance in the first place.
If you’re a parent looking for a policy that can help keep your kids financially secure in the event that anything happens to you, term life insurance is probably your best bet. It lasts only a set number of years, which you can ensure will last until your children will probably have moved out and begun their lives.
If, however, you want your policy to ensure that a spouse is protected, whole life insurance may be preferable. This policy will be much more expensive than term life insurance, but it is essential for those specific needs. This is why it’s so important to consider the purpose of your policy before choosing one.
2. Failing to Do Your Research
The easiest way to get a life insurance policy that is either a problem or does not fit your needs is by accepting the first policy that comes your way. Don’t pay attention to just the premiums, either.
“Price is not an indication of good coverage,” says Farmers Insurance agent Earl Jones. “Just because the price is low, doesn’t mean the life insurance policy is effective. Some life insurance policies have a clause that requires a person to live for two to five years after the policy is issued before the policy will pay out anything other than the paid premium.”
You should consider the riders that each program offers, which can range from accidental death, to family income benefits, to waiver of premiums in the event of permanent disability. Each of these riders could have a significant impact on your family’s future in the event of a tragedy.
However, though you should not focus entirely on your premium, make sure that you know roughly how high it should be by comparison shopping.
3. Not Comparison Shopping
One mistake that people make is to check only one company’s policy offerings. You may be quoted a higher-than-average price and not even realize it.
More than half of all Americans overestimate the cost of life insurance, according to True Blue Life Insurance, which could mean that many risk vastly overpaying for their policies. By comparison shopping, you can make life insurance much more affordable.
If a company offers free quotes, take advantage of them, so that you can accurately gauge how much coverage you can get and how high your premiums will likely be.
4. Choosing Insufficient Coverage
In the event of your death, it is easy to assume that a payout of $150,000 could be enough to let your family live comfortably for a while. The problem is that the life insurance payout needs to last your loved ones until they can get back on their feet.
It’s important to consider that lenders will still expect them to pay their bills.
If you have children, a mortgage, an auto loan, or anything else, your family will still be expected to pick up the slack, without your salary to fall back on.
They’ll also need to worry about additional costs, if you don’t have burial or funeral insurance. So, while $150,000 in coverage might comfortably last them for a year or two, it won’t help them handle life without you in the long term.
5. Relying on a Group Life Insurance Policy
Group life insurance is a single coverage policy for a group of people, and it is usually used by businesses. Though group life insurance policies can be great and convenient, they can be a problem as many of these policies won’t provide your loved ones with as much as they might need.
These policies are meant to be both transitional and supplemental, which means they won’t pay nearly as much as individual policies.
Group life insurance will help, but it won’t help forever.
Another reason to avoid depending on group life insurance is because it is often tied to one’s employment. If you’re laid off, you’ll lose your coverage, which could mean that your family will not have even basic support in the event of your premature death.
6. Choosing the Wrong Beneficiary
The beneficiary is probably the most important aspect of life insurance. After all, the entire point of the policy is to ensure their financial security, isn’t it? With that in mind, you want to be sure that you aren’t setting them up for failure before you’ve even started.
If you’re a parent, seeking to support your child, you may be tempted to list your children directly as your beneficiaries. This isn’t recommended. What you should do is to establish a trust and name the trust as the recipient.
This ensures that you won’t be handing large amounts of cash directly to children, who may not know how to manage it wisely. It also ensures that state laws, regarding the use of income by minors, won’t hamper them in the event of your death.
You should also avoid naming your estate as your beneficiary. In many states, this will result in inheritance taxes that will diminish some of the income. It also grants creditors access to these funds, which could mean that your family will receive little in the way of aid, despite years of funding the policy.
In addition, consider having at least two backup beneficiaries. One of your beneficiaries could die before being able to receive the insurance payout. It is important to know that the payment will still go to a designated individual or trust, rather than to your estate.
7. Not Keeping Your Policy Up to Date
Circumstances in life change, and that means that your life insurance policy needs to change with them, if you want to avoid having problems with your insurance.
Over time, you may need to update your beneficiaries. “I have seen people forget that they had a life insurance policy, got a divorce, and remarried… and left their ex as the beneficiary on the policy,” Jones adds.
If you qualify for a raise at work, it may be time to consider switching policies. A new policy might have a higher premium but will also be more beneficial to your loved ones.
On the other hand, if you are in the midst of a financial crisis, don’t just accept a high premium and move on. Contact your life insurance provider to see if you can adjust your policy to one that best suits your situation.
8. Waiting Until Later in Life
Though it is very easy — and certainly very common — to put off searching for a good life insurance policy, what many people may not realize is that procrastination could cost you money. Life insurance costs more with every year as you age, so waiting just a few years could mean a significant increase in your premiums.
To make matters worse, if something does end up happening to you, your family may not have the financial means to survive comfortably through the transition period. If you wait too long, it could hurt both your wallet and your loved ones.
9. Making the Decision Alone
Like many decisions in life, choosing your policy isn’t one you should make solo. In addition to speaking with a financial advisor, consider discussing your ideas with loved ones. The beneficiaries will need to know how any decisions will affect them, and letting them know now can help avoid some of the hassle that comes with collecting on the policy, if the worst happens.
By ensuring your loved ones understand the terms, you’ll be making sure that their grieving process won’t be interrupted by lawyers and asset management.
Friends and family can also help point out any details that you might have missed, which could help you a great deal in the long run.
10. Not Considering Life Insurance
Though it is painful to think about the reasons why you might need life insurance, if you have family members depending on you, it is essential that you at least consider taking out a policy.
In the event of your unexpected death, your loved ones will be left to mourn; a life insurance policy could mean the difference between a typical mourning process and a mourning process combined with financial turmoil and other problems.
You may not want to think about it, but, for your family’s sake, at least take a few days to look over different options to ensure that they’ll be secure in the event that they don’t have you with them anymore.
Additional reporting by Natasha Cornelius.