People can make a lot of mistakes when it comes to life insurance. Life insurance is complicated and lots of people give different advice. There are a lot of agents out there who are not highly trained, and some of the talking heads on television don’t always give the best advice because what they say is very generic. It can be easy to fall into a trap and make a costly mistake with life insurance. Here are 15 big mistakes that people make when it comes to life insurance, and what you can do to fix and avoid them.
Not Naming a Beneficiary
This is one of the most common mistakes that people make and it can be very costly for the intended recipients of the life insurance policy. It is also one of the easiest problems to fix and avoid. When you don’t name a beneficiary, or you don’t have any remaining living beneficiaries, the death benefit is paid out to the estate of the insured. This means that it now needs to pass through estate probate. It may be subject to estate taxes, and worse, it may not go to the intended beneficiaries. It can also be claimed by creditors if the insured died with a lot of debt. It is very important to name beneficiaries and keep them current.
Opting for Whole Life Over Term
Most people do not need whole life insurance. They need coverage to protect their families until their children grow up and they and their spouses retire. For most, a 20-year term policy gets them to this point. The premium payments on term life are much less expensive than whole life insurance. People are usually better served to “buy term and invest the difference” if they are inclined to pay for a whole life policy, or to simply afford more coverage than they would be able to afford if they purchased a permanent policy. $500,000 of term life insurance can cost less than $20 per month for a young healthy female, and only a few more dollars per month for a healthy young male. Because term is so affordable and so many people are on budgets, most people should opt for term life over a whole life policy.
Not Getting Enough Coverage
Life insurance policies sound like they have big numbers. When people hear an agent or advisor recommend a policy that is hundreds of thousands or even millions of dollars in coverage, their first instinct is often to think that it is overkill. This is a mistake to think this way. Remember, that money needs to last your family, children, and beneficiaries for a long time. College educations can cost hundreds of thousands of dollars per child, alone! Housing costs keep rising faster than inflation, and inflation is a constant and steady reduction in the value of a dollar. Opt for more coverage than you think you need because it will probably be spent much faster than you think it will. As mentioned above, it is also pretty cheap to get a lot of term life coverage if you are in reasonably good health so it is well worth a few extra dollars per month for the additional coverage.
Not Getting Long Enough Term
While not everyone needs whole life insurance, it can be a big mistake to not get a long enough term policy. You most likely need the life insurance to cover the rest of your working years, and retirement ages keep getting later and later. It can also be much harder to get a new life insurance policy later in life since most people have common health ailments strike them. Since term coverage is generally so cheap, make sure that you extend your policy a bit longer than you think you might. That way, if you need life insurance later you will still be covered and paying lower rates than if you try to buy a new policy far into the future. It is far more price efficient over the long term to buy a longer policy length than to buy multiple short policies over time.
Not Considering Whole Life if it Makes Sense for you
Whole life insurance is a niche product that was oversold for years. This gave it a bad reputation which is a bit undeserved. Whole life insurance does cost more in annual premium, and the commissions are higher for agents who sell it, but permanent life insurance coverage does have a place for some. Whole life insurance has some distinct features and benefits which are different than term:
- It pays a dividend, which grows over time and eventually will cover the entire premium in most cases.
- It lasts for an entire lifetime.
- It is an asset with a growing cash balance. When you cancel your policy you get money back, and you can take loans or partial surrenders whenever you want.
- It provides a high risk-adjusted return. In other words, it is not risky to put your money into whole life insurance, but the internal rate of return of the policy will be higher than assets of comparable risk profiles.
While some people do not need life insurance to last an entire lifetime, others do. Examples include people splitting estates equally, avoiding the estate tax, funding a trust, or making a sizeable donation to a charity at death. While the popular mantra of “buy term invest the difference” is good advice for many people, some people should consider whole life insurance a viable option.
Not Comparing Quotes
If you go to a career life insurance agent who works for a major insurance carrier, they are going to push the products from that carrier and probably not compare quotes from every company. Depending upon your age, sex, and health, one company may be vastly cheaper than another for your particular case. You should work with an independent brokerage, or at least with an agent willing to look at products from multiple companies.
Surrendering Your Policy too Soon
If your budget is feeling tight, a life insurance policy can seem like a natural place to cut back. Death usually feels far away and intangible. If you die, your family will have problems either way. You will apply for a new one as soon as you have more money and odds are you won’t die in between. All of these excuses make sense, but it may not be that simple to drop your coverage and get it back before you die. As you get older, life insurance gets more expensive. Odds are you will also be less healthy. You may not even be able to qualify for coverage if you have an unexpected health condition.
You may also feel like you no longer need life insurance after a certain point in life, but you still have time left on your policy. Make sure that you consider the entire picture before you surrender it. Do your grandkids need help with education expenses for instance? Will your spouse have a more comfortable retirement with life insurance, and is this protection worth the money? Will you potentially need it again in the future, and does it make more sense just to keep the coverage? Don’t drop your coverage too soon. Make sure that you understand your long term financial situation before surrendering a policy.
Buying a Universal Life Insurance Contract
Universal life insurance is another form of permanent life insurance coverage. Unlike whole life which is very structured, universal life insurance allows flexibility regarding the premium payments made, and the death benefit can even adjust as the cash value changes. It also does not receive dividends, but the cash value is credited interest at a prescribed calculation over a base rate. Universal life is also very risky.
The actual cost of insurance on these policies rises over time as the insured person ages. Sometimes, people have paid massive sums of money into their policies, and when they get into their 80s and 90s the insurance cost eats up all of their cash value and causes the policy to cancel, right before they die. They are also very complex products, and their success requires a lot of funding in the early years. They are not really advantageous to whole life insurance. A variable universal life insurance policy actually invests in accounts similar to mutual funds that invest in capital markets. People are usually better served to keep their life insurance and their investment accounts separate though since they have different purposes.
Thinking that you Get your Money Back When you Cancel a Term Policy
Whole life insurance has a cash value, term does not. Unless you specifically buy a “return of premium” term life insurance policy and follow the rules required to have your premiums returned, you will not get any money when your policy expires or when you cancel it. Don’t assume that you can take a portion of the “death benefit” early, either. The only time you can do this is if you have an accelerated death benefit rider, and the insured person is terminally ill.
Not Naming Secondary Beneficiaries
A secondary beneficiary is a back-up beneficiary. If the primary beneficiaries die before the insured, the death benefit gets paid into the estate instead of flowing directly to the beneficiaries. This can cause it to be subject to probate and estate taxes and could be claimed by creditors. It is much safer to name secondary and even tertiary beneficiaries just in case.
Not Using the “Per-Stirpes” Designation if it Applies
If you name multiple primary beneficiaries, and one passes away, the death benefit that they would have received gets spit among the remaining primary beneficiaries and does not go to any secondary beneficiaries. If you want the portion of the death benefit that the deceased beneficiary would have received to go to secondary beneficiaries, it is important to utilize the “per-stirpes” option for the payout. This means that the other primary beneficiaries will still receive the portion that they were due, but the amount that would have gone to the deceased beneficiary now flows to a secondary beneficiary or beneficiaries.
Taking a Partial Surrender and not a Loan
If you have a whole life insurance policy you have two ways to access the cash value in the policy. The first is a withdrawal, but the death benefit is reduced by the amount of the withdrawal permanently. The second is a loan. The death benefit is reduced by the amount of the loan outstanding at death, but a loan does not reduce the death benefit for good. While a loan does have interest due, if there is any chance that you will repay the loan back into the policy make sure that you don’t make a withdrawal when a loan works just fine.
Missing a Payment
Know that missing a payment creates an opportunity for your policy to lapse and for you to lose all of your coverage. It is best to put the premium payments on autopay so that you know they come when they need to. Life insurance companies do all provide a grace period, as required by law, that gives the owner 30 days after a missed payment where the policy does not lapse. If nonpayment lasts any longer the policy will lapse and need to be reinstated. If the policy is not reinstated soon enough, you will need to purchase a new policy.
Naming a Minor as the Beneficiary
A minor cannot collect life insurance proceeds until the court appoints a legal guardian to the child. This process can take quite a bit of time, and also takes a lot of expensive attorneys fees. It is much smarter to name a spouse, or if that is not the intent to leave the money to a life insurance trust. The trust has an appointed trustee which will oversee the distribution of the funds to the minor. You can also fund a UTMA account, which similarly to a trust has an appointed custodian until the child reaches the age of majority.
Not Telling People About Your Life Insurance Policy
You may want to keep your life insurance policy and finances a secret for a lot of good reasons. You may not want people to fight over your estate before you pass away and you may not want people to befriend you or treat you differently in order to get more money from your estate. Even though these are valid reasons to avoid telling people about your policy, you put your beneficiaries at risk of not getting the proceeds if they do not know about the policy. They may not know to file a claim when you pass away. If you do not want to tell your family, at least let your financial advisor, attorney, and accountant know about its existence.