Life insurance is the one type of insurance that isn’t really about protecting yourself. It’s there to protect anyone who depends on you for financial support.
If you die unexpectedly or before you planned to retire, your life insurance policy will pay out to your named beneficiaries. This money can replace your income so your family can continue paying their bills or cover additional expenses, like childcare. It could also help them pay off debt or fund your kids’ education.
“I think it’s something that’s overlooked, and I think it’s important, especially for Gen X and Gen Y,” says Mark Maurer, CFP®, president and CEO of insurance advisory firm LLIS. “It’s not as expensive as you think, and when it comes to protecting your family in your income-earning years, something is better than nothing.”
To purchase life insurance, you’ll most likely have to go through an interview process and take a medical exam, which is usually called a paramed exam. This usually includes your height and weight, blood pressure, a blood draw, a urine sample, and maybe a review of medical records requested from your doctors.
Generally speaking, the younger and healthier you are, the less expensive your premiums will be. But be aware that your family history might play a larger role than you expect.
Why jump through these hoops? If you financially support anyone else, life insurance will be there to protect them after your death by helping to replace your income.
Term Life Insurance
Term life insurance is the most cost-effective kind of life insurance and the only kind most families need. With term life policies, you pay an annual premium for a set period of time (usually 20 or 30 years), and if you die during that time period, your beneficiaries will receive a death benefit meant to replace your income until whenever you would have retired.
Term life insurance is “true insurance, like health insurance, auto insurance, homeowners insurance,” Mark says. “You pay for it and it’s there if you need it.”
Many employers offer employees a group life insurance policy worth one to four times your salary. On top of that, employees can elect to add additional coverage. (Note that any additional coverage is usually paid for by the employee.)
There’s no reason not to take this coverage if your employer is paying for it, but it’s probably not a substitute for your own policy — especially since you’ll lose the coverage if you leave that job for any reason. Some coverage is “portable,” meaning you can pay to take it when you leave, but it’s usually more expensive than buying your own individual policy.
If you don’t have any dependents, then the group term life insurance coverage you have through work might be enough for you. Make sure that you designate a beneficiary. This is the person who you would want to receive the life insurance proceeds should you die. This money could help pay for your funeral expenses and pay off any debt that you have.
Level Term vs. Annual Renewable Term
Some life insurance policies are “level term,” which require a fixed premium every year for a set period of time. These come in a variety of different bands but 10-year, 20-year and 30-year terms are the most popular.
Other term life insurance increases annually, which is known as Annual Renewable Term. This means premiums start out fairly low and then increase as you get closer to the policy’s expiration date.
I almost always recommend applying only for Level Term, because locking in the low rates while you’re young and healthy is very beneficial and your premiums stay the same year over year. I have yet to see a situation where it makes sense for someone young to buy an Annual Renewable Term policy.
Can I Cancel My Term Life Insurance?
If you stop paying the premiums, the policy will be cancelled and you will no longer have coverage. There is usually a 30-day grace period after your premium due date in which you can pay to retain your policy, as long as you catch up on your payments.
If you cancel your policy but later decide you still need coverage, you will have to go through underwriting again — and risk the chance of your premium going up.
What Happens When the Term Ends?
Term life insurance policies cover you for a set term, and when the term is up, your coverage ends. There’s no cash value like there is with other types of life insurance. Remember, this is not an investment — it’s a way of protecting your family financially in the case of your death.
If you get to the end of your term, the good news is: you’re alive! Hopefully you and your family are in a much better financial position than you were when you took out the policy. If your kids are grown and you’ve planned for college costs and saved for retirement, then by the time your policy term ends, you may no longer have a need for life insurance.
However, if you feel like your family would be in a tight financial position if you passed away unexpectedly and they lost whatever income you’re still earning, then you can apply for another term life insurance policy after your term ends.
Whole Life Insurance
Then there’s “whole life insurance,” which is exactly what the name says it is: coverage that lasts for your whole life, not just a set number of years. (“Permanent life” and “universal life” are types of whole life coverage.)
Whole life insurance policies include life insurance that will pay out upon your death, but they also have cash value — meaning you can make withdrawals from the policy the way you might from a retirement account.
GYP asked Mark Maurer to explain whole life policies in more detail. A few decades ago, he says, these policies were a popular way to save money for retirement — the insurance component would support your family if you died during your income-earning years and, when you retired, you could withdraw a portion of the cash value every year, supplementing a pension or Social Security.
Whole life policies work pretty much the same way today: They include both a life insurance component and a cash value, which Mark describes as “forced savings.” When you withdraw those savings, each withdrawal reduces the value of the policy. Once the policyholder has completely cashed out, the coverage lapses.
“Whole life insurance is designed to be around for your entire lifetime, whereas term life insurance just protects your income-earning years,” Mark says. “Like all things financial, most of them are not good or bad, it’s just how appropriate it is for a particular client.”
Because of their cash value, whole life policies are sometimes marketed as investment vehicles, especially to younger buyers. GYP’s “simple first, sexy later” approach means we don’t recommend this. First of all, whole life policies are significantly more expensive than term life insurance policies. They also tend to be sold by insurance agents who get big commissions. (Sometimes the commission the insurance agent receives is equal to your first two years of monthly premium payments!)
I’ve only seen extremely rare cases in which whole life insurance makes sense for a family. Generally, when someone has already paid premiums for over a decade or two, they are planning on using this money as part of a complex estate planning strategy. But for most people, it’s both easier and cheaper to leave wealth to your loved ones through an estate plan.
That said, if you want whole life coverage later in life, you might have the option of converting a term life insurance policy to a permanent or whole life insurance policy without a medical exam. Review your policy for details.
How Much Life Insurance Do You Need?
Remember that the purpose of a life insurance policy is to cover your income for the rest of your working life. If you’re looking for a number to start with, multiply your income by the number of years you have left to work.
Every life insurance provider has an internal needs calculator that they use to determine how much coverage they’ll recommend. It’s based on income, but also on expenses — a mortgage, the cost of sending your kids to college, and more. A $1 million policy lasting 20 to 25 years can be a good starting point.
In practice, how much life insurance you need can vary a lot depending on your family situation. It’s not just about replacing your paycheck, but about reducing the amount of stress your family takes on as they work to cover big expenses.
When Should You Buy Life Insurance?
According to Mark, “realistically, the time when you need life insurance is when you can say, ‘someone will experience a financial loss at my death.’” When he and his wife got married, they didn’t have many assets, but when they bought a house, the mortgage payment was based on both their incomes.
“Then, once you have kids, it’s an exponential boom,” Mark says. “Not only is there a mortgage, but now there’s somebody who is reliant on people to care, clothe, feed, pay for college, everything, for the next 18 to 20 years. That’s usually when the need goes from, ‘Maybe we need a life insurance policy to cover a mortgage’ to, ‘Wow, we need to make sure that we’ve got 10 or 15 or 20 times our income covered in case something happened to one of us parents.”
Buying life insurance requires a medical exam when you enroll, but that’s probably the only exam you’ll have to take. The younger and healthier you are at that time, the cheaper your coverage will be throughout your life.
If you and your spouse or partner plan to have kids, try to buy life insurance before you get pregnant for the first time in case complications arise.
Also, remember that life insurance isn’t just for income-earning parents! Stay-at-home parents need to be covered too. If your stay-at-home spouse were to pass away, you might have to hire childcare or home help, which can get expensive fast.
When you purchase a life insurance policy, you’ll designate one or several beneficiaries to receive the payout. Like your estate planning documents and retirement accounts, make sure to update these beneficiaries whenever you undergo a major life change, like a marriage or divorce.
How To Buy Life Insurance
How much life insurance coverage you need and what kind of policy you need depend on your set of circumstances. Every family is different. Every policy is a little bit different, too. An insurance agent who works with a variety of carriers can help make sure you find the policy that best fits your needs.
“Each person is different,” says Mark. “Given their particulars, how do we blend their needs and find the best insurance design and the best cost for the client?”
That’s part of what Gen Y Planning and other fee-only financial advisors do for our clients: We talk about how much coverage and what type of policy they need and refer them to an agent, like Mark, who can help them buy the best policy.
If you’re shopping on your own, take a look at Quotacity and Policygenius to get an idea of what’s out there. Look for a brokerage firm that shops the top carriers for the best rates and ask your friends and family for recommendations.
If you don’t have children or family members who depend on you for financial support, then you probably don’t have a strong need for life insurance right now. Take advantage of whatever policy is offered in your employee benefits, if any, and remember to revisit life insurance as your net worth grows and your life changes!