Life insurance: When, how much to buy

PERSONAL FINANCE

Dollars & Sense

November 04, 2001|By EILEEN AMBROSE

PERHAPS after drafting a will, the most dreaded financial task for people is buying life insurance.

"It's something they prefer not to think about and like to procrastinate about. A good part of it is that we are a death-denial society," said Ed Graves, a life insurance professor at the American College in Bryn Mawr, Pa.

Of course, that was more the case before the terrorist attacks. That was also before reports of surviving spouses struggling to make ends meet and New York Mayor Rudolph Giuliani's heart-rending estimate of 10,000 children losing a parent on Sept. 11.

Now more people are thinking about death and how their families would financially cope without them. Life insurance companies report policy inquiries have gone up 30 percent to 40 percent since the attacks.

Of course, not everyone needs life insurance. Singles with no one relying on their paycheck, for example, likely don't need insurance. Neither do those with enough assets to maintain the lifestyle of their spouse and children.

Basically, people need insurance if someone else relies on their income or the services they provide, said Peg Downey, a financial planner with Money Plans in Silver Spring. For example, if you care for aging parents or are a stay-at-home parent, you need insurance to cover the cost of someone providing that care if you die, she said.

Life insurance also is used by those with sizable estates to pay off hefty estate taxes. (The estate tax is being phased out over a decade, although some doubt the tax will disappear forever.)

And life insurance can be useful to those who develop a catastrophic or terminal illness, allowing them to collect all or part of their death benefits while alive through accelerated benefits and other means, Downey said.

Once you determine if you need insurance, the next and tougher question is: How much?

The rule of thumb is five to 10 times earnings of the insured. That wide range is a sure sign that the rule is not an exact science.

To get a better handle on needed coverage, figure your immediate and future financial obligations - from credit-card debt and mortgage to children's college education - and the type of lifestyle you want to provide for survivors, Downey said.

"Do you want to provide for your spouse so they never have to work again or just provide so the house gets paid and college education gets taken care of?" she said.

Once you figure expenses - not forgetting to factor in inflation - then look at what resources you have that will reduce the amount of coverage you need to buy. Those income sources can be life insurance from an employer or veterans' program, investments and Social Security survivors' benefits.

Fortunately, there are online calculators to figure insurance needs, including www.financenter.com, www.tiaa-cref.org/lins/howmuch.html and www.insuremarket.com.

Once you know how much coverage you need and for how long, you must decide what type of insurance to buy. Basically, there are two kinds: term and permanent.

Term insurance covers you for a specific period, like 10 or 20 years, and pays a death benefit only. With level term, premiums stay the same.

Term is much cheaper than permanent insurance when you buy it at a younger age, say, 30. If you renew the policy, though, the premiums can be substantially higher because you're older and the chances of dying greater.

Permanent covers you for life, unless you cancel the policy. It not only provides a death benefit, but part of your premiums are invested tax-deferred and build up a cash value. You receive the cash value if you cancel the policy, although taxes may apply. You also can borrow against the cash value.

There are different types of permanent insurance, each with its own features and investment options. Whole life, for instance, offers a more predictable rate of return; universal life gives you flexibility on premiums and death benefits; and variable life allows you to choose among groups of investments, although you shoulder the investment risk.

What type is best for you?

Consumer advocates and many financial advisers typically recommend term. It's inexpensive and policyholders are usually better off salting away the money saved on premiums or investing it, particularly in tax-deferred investments, such as a 401(k) or individual retirement account, experts said.

Ideally, once the insurance expires, your investments have grown enough to provide a financial cushion, experts said.

Permanent policies "are so expensive and 50 percent are dropped within the first 10 years," said Robert Hunter, director of insurance for the Consumer Federation of America. Drop a policy too early, and there may be little or no cash value built up, or you may be hit by a surrender charge for canceling, he said.

Some experts, though, say if you need coverage for more than 20 years, permanent insurance tends to be the way to go.

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