Life insurance exists to protect and provide for your family in the event of your death. Life insurance can be complicated, with so many products and choices such as term or whole life, who to choose as beneficiary, and how much coverage to buy.
Some common misconceptions and mistakes when purchasing life insurance policies can lead to people being underinsured, having the wrong coverage, and experiencing a decline in living standards. Here are the top five life insurance mistakes to avoid.
1.Not Buying Enough Coverage — Being Underinsured
Many people are not sure how much life insurance is sufficient to protect the ones they leave behind. Many studies show that U.S. households are underinsured, and young couples with dependent children typically underestimate how much life insurance they will need.
Some common reasons people are underinsured include:
• They believe life insurance is too expensive or complicated.
• They do not adequately calculate the needs of dependent children.
• They do not consider the work done by a stay-at-home spouse to be an expense that needs to be covered.
• They do not cover the income of secondary earners.
You can calculate how much life insurance you need by using an Economic Security Planner, such as the one offered by ESPlanner. When filling out a life insurance policy application and determining how much life insurance you need to purchase, consider buying enough to cover the costs of:
• Burial or cremation
• Bills or debt payment
• Children’s care until they reach adulthood
• Children’s education
• Mortgage payments or paying off a house
• Retirement security
• Maintaining your family’s current lifestyle
2. Buying Life Insurance Before You Need It
Life insurance is one of those essentials that everyone believes he or she automatically needs to have. If you are single with no dependents, then you likely need only enough coverage to pay for burial expenses, so as not to burden your parents or siblings. If you have a spouse, children, and mortgage, then you need more substantial coverage.
You may think that life insurance will be cheaper when you are younger, and choose to get it early in your life. Policy premiums are indeed cheaper for younger and healthier people because they are statistically more likely to live longer before they need to use the insurance. However, since a young person is less likely to need the insurance, paying premiums during your twenties may be a waste of money. A good rule of thumb is to wait longer to purchase life insurance if you are single or if no one would suffer financially if you were to die.
3. Buying Life Insurance from a Variety of Sources
Some people believe they will be overprotected if they purchase insurance from a variety of sources. Some examples are:
• A bank may offer mortgage life insurance that will pay off a mortgage in the event of death.
• Airlines offer life insurance or dismemberment insurance if you die or are injured in a plane crash.
• Car rental companies and even credit card companies offer various insurance plans to cover expenses.
Paying for insurance through all these of alternative sources is excessively expensive. A standard term-life or whole-life policy will cover these expenses — mortgage, car payments, car accidents, credit card debt — at a substantially lower cost. Some experts suggest that consumers buy life insurance only from an insurance provider.
4. Forgetting to Review or Update the Policy
A life insurance policy should not be written and forgotten until a tragic event. Many life events warrant a review of a life insurance policy.
Oftentimes ex-spouses are recipients of policies, or subsequently born children are missing from policy beneficiaries. Review or update your policy after such events as the birth of each child, a marriage, or a divorce. Also update your policy after the death of a beneficiary.
Generally, it is wise to review or update a policy every three years. If you bought term-life insurance, be aware of when the term is up and renew your policy in a timely manner to avoid gaps in coverage.
5. Naming Beneficiaries Who Are Minors or Incapable of Making Financial Decisions
Although minor children or grandchildren are likely going to be the end recipients of much of a life insurance payout, they should not be named as the beneficiaries. Minor children are usually too emotionally insecure to handle large sums of money. In addition, states and large insurance companies will not pay large death benefits to minors. Another consideration is to avoid naming as beneficiaries mentally disabled or otherwise disabled persons who are not able to make complex financial decisions on their own.
Instead, set up a trust for minors or a disabled beneficiary and name the trust as the recipient of the insurance policy payout. With a trust, you can specifically write terms and restrictions of payouts to the beneficiary or for the beneficiary’s care. For a smaller expected payout, consider a settlement option in which proceeds are paid over a period of time rather than in a lump sum.