2:49 PM EDT, June 12, 2014
The topic of life insurance doesn't have much going for it. First, it's about insurance, which many people find boring and complicated. Second, it can involve paying money for something you may never use.
And, it's about death.
Those are difficult hurdles and probably among reasons why many surveys show Americans are vastly underinsured when it comes to life insurance, which might better be called "income insurance" because its primary purpose is to replace income from a family breadwinner.
"Selling life insurance is an uphill battle," said Byron Udell, CEO of online life insurance broker AccuQuote.com. "It's not a product that's fun to buy."
But life insurance should be a fundamental part of financial planning for those who have others relying on their income.
Yet statistics show ownership of individual life insurance policies is at the lowest level in 50 years, with only 44 percent of households owning them, according to the insurance industry group LIMRA. And 86 percent of people say they haven't bought life insurance because it's too expensive, yet they overestimate its cost by more than two times, the group found.
A national survey commissioned by New York Life Insurance Co. recently found that Americans' gap in protection worsened considerably since the Great Recession, amounting to a $320,000 shortfall, up from about $289,000 in 2008. Americans say they want enough life insurance, on average, to cover expenses for at least 14 years after the loss of a breadwinner. But they have only three years of protection in place.
"It's no surprise that Americans are underinsured. What did surprise us was the magnitude of the gap and the fact that it has grown so dramatically since 2008," Chris Blunt, co-president of the Insurance and Agency Group of New York Life, said in releasing the results.
Also concerning is what the survey found about Americans' perception of what life insurance is for. A majority said the top reason for buying it was to cover funeral expenses, but paycheck replacement is far more important.
The good news for consumers is, the basics of life insurance continue to apply. "The beauty of life insurance is that it's not a fast-moving industry," said Amy Danise, editorial director for Insure.com. "Unlike health insurance, where what you know one month is wrong the next month, life insurance advice is consistent."
Here is some of that advice:
Determine whether you need it. The overly simple rule is that single people don't need life insurance, married people might and parents of school-age children do. The specific answer is easy to determine. Ask yourself, "Would anybody be hurt financially if I died and wasn't bringing home money anymore?" If yes, you need life insurance.
The cash beneficiaries get, known as the death benefit, replaces your income and can help your family meet financial needs, such as living expenses, including the mortgage or rent and health insurance, as well as kids' college funding, according to the Insurance Information Institute. There is no federal income tax on life insurance benefits.
How much? Numbers get huge in a hurry when talking about coverage amounts — $500,000 or $1million might seem ludicrous but aren't for many people.
To get your head around such large dollar amounts, ask yourself a few questions, Udell said. For example, if you make $80,000 and are looking at $500,000 of life insurance, that's about six years' worth of replaced gross income. "When you die, and you will die, are you planning to be dead more than six years?" Udell asks.
Or, "If I wrote you a check for $500,000 right now, would you agree to work for the rest of your life for no pay?" Most people wouldn't, he said. Or, if you were out jogging and got hit by a reckless beer truck driver and died, how much should your family sue the beer company for: $500,000 or millions of dollars?
"I think there's a fundamental misunderstanding about what the economic value of a human life really is," Udell said.
Rules of thumb say you should buy from five to 20 times your income, which is such a wide range as to be useless — and such simple calculations are panned by experts.
Brokers and online calculators can help determine how much you need, including ones at lifehappens.org, accuquote.com/needs.cfm and bankrate.com. Just realize most insurance professionals and online calculators have a financial interest in selling you more insurance, not less. And no, the amount of life protection you get through your employer is not enough.
Rates. The good news is that simple term insurance — insuring your life over a specific time for a specific amount of money — is relatively inexpensive. A 40-year-old male nonsmoker in a good health can get $500,000 worth of coverage for as low as $350 a year, Udell said, adding that rates, on average, haven't changed much over the past decade. But during the early 1990s that same coverage cost about $1,000 per year.
"People are usually pleasantly surprised at how inexpensive it is," Udell said.
Term or perm? Term life is the easiest type to understand. For example, 20-year level term means you will pay the same premium for 20 years in exchange for a specified payout if you die within that period. If you don't die in that time window, your beneficiaries get nothing. But maybe that's OK because after that time, your children will be grown and have their own incomes. And you're confident that your retirement nest egg will be big enough to support your spouse.
Permanent life insurance, such as universal life or variable universal life that have investment components, can be much more complicated and much more expensive. But they can make financial sense. Make sure you thoroughly understand what you're buying, Danise said.
A new type of policy that's gaining traction allows you to tap your life insurance death benefit before your die as long as it's for long-term care expenses, Udell said. "And they're not that much more expensive," he said.
For more information on life insurance types, seek out a broker, either online or in person, and read up at such websites as insureuonline.org, iii.org and lifehappens.org.
If you just want life insurance to protect from financial disaster, get term life. You can always get a different life policy later, assuming you're still in decent health, and can cancel the current one. In the meantime, you'll be covered.
Shop it. As with other types of insurance, premiums can vary widely, so get multiple quotes or use a broker. But don't let indecision delay getting the insurance you need. "Dying without coverage is a lot bigger problem than paying too much," Udell said.
Don't keep it a secret. Tell beneficiaries that your policy exists, Danise said. "We receive tons of questions every year from people whose relatives passed away and mentioned having life insurance but didn't leave any information," she said. "Imagine paying for life insurance for decades and decades and having that money go down the drain because your beneficiaries can't make the claim."
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