September is “Life Insurance Awareness Month,” and while it won’t be celebrated with marching bands and fireworks, it might give some Americans pause to think about their family’s financial situation.
According to LIMRA, an international association of life insurance and financial planning companies, 40% of Americans have no life insurance, and half of those who do are underinsured. Of particular concern, one in three parents with children under 18 have no life insurance.
Why you may need life insurance.
“We’ve all been in a bad financial situation, and there aren’t many things worse,” says Kyle O’Dell, managing partner of O’Dell, Winkfield, Roseman and Shipp, a retirement income planning firm based in Denver. “Being broke is being broke, and that is not good. The way to look at life insurance is as income replacement.”
The aim should be to replace the insured’s income at a level of 10 to 15 times one’s annual salary, O’Dell says. So if you make $50,000, you should shoot for a policy of $500,000 to $750,000.
“You want to be sure that your spouse can finish raising the kids and can send them to college,” he says. “The way I would reference life insurance is that it’s like a love letter to your family if you pass away. ‘I cared about you when I was there, and I care just as much about you when I’m gone, and I want to make sure that you don’t struggle financially.’”
Why you don’t want to think about it.
Reasons for the lack of receptiveness toward life insurance range from feeling it’s too expensive to being overwhelmed by the options available to feeling that the payoff could be far in the future, so why worry now?
“We’re all living longer,” O’Dell says, “so I think people are thinking, ‘Why would I buy insurance in my 20s or 30s when I’m going to live another 50 or 60 years?’ Plus, families are on tight budgets, and they have to decide if they want to spend an extra $100 a month on insurance for something that they may not need for another 50 years.”
Do you really need it?
If someone is depending on you financially, then probably yes, but for others, no, according to J. Robert Hunter, director of insurance at Consumer Federation of America. “Only buy life insurance when you have a dependent to protect, usually a child."
What kind should you get?
There are two basic types. Term insurance covers you for a set period of time, such as 10 or 20 years. It's the more affordable type, however as you get older, if you renew your policy for another term, the price goes up. Whole insurance, also known as permanent insurance, lasts a lifetime — as long as you keep up with the premiums — and it has an investment vehicle attached. These policies tend to cost much more — and they sometimes come with more fees and high sales commissions — however, the price usually stays the same as you get older.
“For the majority of consumers, term life insurance is the right choice,” Hunter says. “Term is very inexpensive when you are young, and that is when you need it most.”
Term costs less because there is a lot of competition for this type of insurance, says Tom Warschauer, finance professor at San Diego State University. It is bought "by more sophisticated investors who prefer to manage their own investments."
O’Dell, on the other hand, likens term insurance to renting a policy. “When that term expires, you have nothing to show for it,” he says. “Most people drop the coverage in their 60s because it becomes too expensive.” Instead, he favors the permanent kind of life insurance as he says it’s a good place to accumulate some cash.
“You do build up savings inside that policy that can be accessed at any time,” he says. “You can use it for your kids’ college education, or it’s an emergency fund. It’s a great retirement vehicle because you can access it in a tax-advantaged way or even tax-free.”
The option San Diego State finance lecturer Seth Kaplowitz says may be best is a portfolio of whole life along with some term coverage. “If I were a young person, in good health, I would get a whole life policy because the premiums will be low, and I would be able to build up the cash value, and eventually, your premiums will vanish.”