The vast life insurance industry features providers that offer a range of policies with distinct advantages and risks. Understanding the difference between these policies is the best way to make an informed decision.
When the choice of life insurance could mean the difference between securing adequate financial protection to loved ones, it’s important to understand the typical mistakes and how to avoid them.
If you’re asking yourself, “Should I get life insurance?” and wondering how to do it right, don’t worry. We’ll walk through the usual misunderstandings surrounding life insurance and how people can bypass the dangers of purchasing life insurance that is inadequate or does something besides what it’s expected to do.
Not shopping around
One of the most common mistakes people make when looking for a life insurance policy is going with the first company they find.
Lots of auto and home insurers also offer life insurance. When an already-familiar insurance company offers a life insurance policy, many people are happy to use that provider without further investigation.
Doing so removes the advantage of knowing whether the life insurance policy is a good deal, and it also puts the policyholder in danger of signing up for a life insurance policy that may not fit their needs.
Life insurance policies vary far more than auto insurance, so shopping around is necessary to understand pricing and which options are available.
If one company doesn’t offer the right kind of term or death benefit, another company probably will. Take inventory of what is needed from a life insurance policy, then search out a company that can provide those needs.
Not evaluating your financial situation
Taking a close look at personal finances is an essential step in purchasing life insurance.
Some may find going through finances a boring or even unpleasant process, but it’s essential. Future finances are directly connected to the current circumstances, and purchasing life insurance is an exercise in financial planning.
One of the most common missteps is waiting too long. Age has a profound effect on the price of life insurance. Life insurance gets more expensive every year you wait.
Health also comes into play due to life expectancy, which is one of the factors weighed by underwriters when creating a life insurance policy. Some insurance underwriters may even request medical records to get an idea of a potential customer’s health.
Some people may be tempted to lie on their application with the goal of receiving a lower premium, but this is a bad idea for one simple reason: if the insurance company finds out the policyholder lied on their application, it could render the policy invalid and leave beneficiaries with nothing.
While a credit score will not directly affect the price of life insurance, debt can have a significant impact on how a life insurance policy plays out after the policyholder’s death.
You should also consider what debts you have. When a policyholder dies with outstanding debts, creditors can come after the person’s estate to reclaim the payments owed. Generally speaking, life insurance benefits are shielded from creditors unless the beneficiary is unable to claim the policy benefits.
If a policy’s beneficiary is already deceased at the time of the policyholder’s death, the policy’s death benefit goes to the estate. In this case, it will be unprotected from creditors. The best way to stop this from happening is to name backup beneficiaries, which most life insurers allow.
Not updating your life insurance policy
Life insurance policies are not something to sign up for and forget. As life circumstances change, it’s important to review the policy to ensure it still fits the reasons why it was originally purchased.
When people move into their twilight years or have changes in their family, they may find themselves desiring more life insurance than what was initially purchased in the policy. To achieve a higher level of coverage, someone might consider dropping their current policy and moving to a new one. This usually isn’t a good idea for two reasons.
First, when a new policy is created, insurers are usually allowed to contest it for a two-year period, meaning they can investigate and deny claims within that time frame. If the policyholder is later in their life, those two years could cause the policy to get held up with investigations should it be needed after the policyholder’s death.
The second reason is many kinds of life insurance policies gain value over time. That value could be severely penalized if the policyholder wishes to cash in the policy.
If additional life insurance is desired later in life, the best bet might be purchasing a separate policy to fit those needs while keeping the original policy intact.
Not understanding the types of policies available
One of the worst mistakes someone can make with life insurance is misunderstanding the kind of life insurance policy they buy.
Some life insurance policies only offer coverage for a set amount of time while others offer permanent protection for policyholders. Some life insurance policies even pay dividends.
Having the ability to parse through the pluses and minuses of different policies is a must for anyone who is interested in purchasing life insurance.
Life insurance can be divided into two main categories—term and permanent.
Term
This insurance only pays when the policyholder dies within the stated term. A term life insurance policy holds no value aside from the death benefit. It is usually the cheapest form of life insurance and can be subdivided into two sections:
Level term: In a level term insurance policy, the death benefit will stay the same through the entire term of the policy.
Decreasing term: In a decreasing term insurance policy, the death benefit will decrease, usually year by year, through the term of the policy.
Term policies have different lengths such as 10, 20 or 30 years.
Permanent
This insurance pays regardless of when the policyholder dies. It’s more expensive than term life insurance, but it also holds more value. Permanent life insurance policies can be roughly subdivided into four types:
- Whole or ordinary: A whole, or ordinary, life insurance policy offers a death benefit and a cash account. The cash account grows as the policyholder pays the premium. This kind of policy can also pay their policyholders dividends.
- Universal or adjustable: This kind of policy is similar to whole life insurance, but it offers more freedom due to giving policyholders the ability to increase their death benefit, as long as they pass a medical examination.
- Variable: A variable policy allows policyholders to choose how they want their cash account to be invested, which can provide financial benefits but involves more risk. If the investments shrink, the policy’s cash value and death benefits could be negatively impacted.
- Variable-Universal: As the name suggests, this is a hybrid of variable and universal policies. The policy allows people to adjust their death benefits and investments.
These definitions are not comprehensive, and there is sometimes further variance within each subcategory. To get the best idea of each policy type, research before signing a contract.
The bottom line
Life insurance mistakes are easy to make, even for the well-informed. It’s a complex industry, and taking the time to learn the ropes will ensure the right policy is in place so your loved ones are protected. When you’re ready to learn how to get life insurance, knowing these pitfalls can help you find the right policy.
Published by: TheSimpleDollar.com