Wes Moss: Life insurance 101 – what to buy and avoid

Wes_Moss-for-Web-smaller-fiCertified financial planner Wes Moss provides personal finance advice and accessible investment strategies. His guest post appears here weekly.

Let’s face it – dealing with life insurance is a drag. Just thinking about it makes you ponder some unpleasant possibilities, and insurance sales pitches are the definition of boring. Plus, who wants to write a check every month for something they hope they never use?

Yes, life insurance is a drag – until it pays off. In truth, insurance is a powerful, essential financial planning tool for most people. A CFP® professional can help assess your insurance needs and recommend policies that meet them. Among the issues to be addressed when considering life insurance:

Do you need life insurance?

Maybe not. If you have no dependents, life insurance is optional.

But if you have a family that counts on your income, life insurance is a must-have. You won’t really understand this until you have children. I remember racing to get a policy signed before the first big trip I took after my first son was born. I didn’t want to get on an airplane until I knew my family’s financial future was protected.

How much insurance do you need?

Your life insurance benefits should replace 100% of your income for at least as long as you plan to work. If you are 30, and expect to retire at 65, you need a policy that will replace 35 years’ worth of earnings. Here’s a simple rule of thumb to calculate the amount of insurance you may need: Take your annual income and multiply it by 18. Example: Let’s say your income is $50,000, multiply that by 18, and you get $900,000. This is a good place to start.

HINT: You may also want to add any significant debts to this number that you would like your family to be able to pay off, i.e. the mortgage balance or the future cost of education. Check bankrate.com for a good online tool (click “Insurance” at top of page for list of resources).

What type of policy should you buy?

TERM! Term insurance is simple and straight-forward. You decide on an amount and how long the coverage should last. Typical intervals are 10, 20 or 30 years. Term is the least expensive type of life insurance, especially if you buy it early. The cost of term coverage goes up every year that you wait to purchase a policy.

Ask your agent about a “renewable” term insurance policy. Such a policy may allow you to maintain coverage if you suffer a life-threatening illness when the original policy is coming to an end.

Where should you buy your policy?

It’s easy to purchase insurance online. But because life insurance is such an important financial tool for your family, I think you should sit down with a reputable life insurance professional. Ask your friends, neighbors or co-workers for referrals. Stick with highly rated life insurance companies.

What should you avoid?

Don’t buy “mortgage life insurance.” Such policies protect the mortgage company, not your family.

Never buy “whole life insurance.” Salesmen pitch these policies as an investment, but they are expensive and not efficient for investors. You will do better purchasing inexpensive term insurance and investing what you save in premiums on a good dividend-paying stock index fund, such as the Vanguard Dividend Appreciation Index Fund.

– by Wes Moss, Atlanta Bargain Hunter

More posts from Wes Moss.

34 comments Add your comment

Atlanta Mom

November 15th, 2010
2:30 pm

Is it true that life insurance proceeds are included in someone’s estate? I always thought that life insurance proceeds are not taxable to the beneficiary, but I recently read an article that stated that proceeds are included in someone’s estate. What is the difference? Also, if this is the case, given the upcoming tax law changes, wouldn’t someone with a relatively small estate but large life insurance policy now have an estate tax issue? If so, is there a way around this?

harry

November 15th, 2010
2:35 pm

Very good.
You just took a topic that we have so much trouble understanding and you have made it very simple.
thanks

Jim @ Acworth

November 15th, 2010
3:02 pm

The only reason I had insurance was for certain debts that my wife would need covered: my house, kids education, retirement before i had enough. I save in other places. Insurance costs seem to be too much when you take all fees into account.

TnGelding

November 15th, 2010
3:09 pm

Buy term insurance? Yeah, but you feel foolish after payng on one for 45 years and then the company jacks the rates up so high you can’t afford it. But then you shouldn’t need it at that age. The best thing to do is sell insurance!

Andrew

November 15th, 2010
3:09 pm

I have a whole life policy that someone sold me years ago. It is only worth $100,000. I also have a term policy worth $500,000. Would you suggest continuing to pay on the whole life policy since I already have it or cancelling the policy? I am planning on purchasing more insurance in the near future. Can I convert my whole life policy to a term policy?

ATL

November 15th, 2010
3:09 pm

First time I have heard 18 x income. Usually the rule of thumb you hear is 7-10 x. Of course you can always sit down and work out the numbers if it concerns you. For many I suspect 18 x is too high, for others perhaps not.

Jim

November 15th, 2010
3:11 pm

My participating whole life and group universal life have performed much better than my mutual funds. If you buy from a good company and take the long term view, whole life is much less risky than buy term and invest the difference.

ccjacket

November 15th, 2010
3:29 pm

AtlantaMom

The proceeds of a life insurance policy that is individually owned is not subject to income taxes. However, it is considered a part of one’s estate, and so the policy might have estate tax ramifications.

Jim H

November 15th, 2010
3:33 pm

Life insurance benefits are not taxed period. Although with Obama in the WH they may be soon.

Benefits

November 15th, 2010
3:38 pm

Atlanta Mom – Life insurance proceeds are not income taxable to the beneficiary. However, the proceeds are considered as part of your estate for estate tax purposes. You can setup an trust to remove the assets from your estate, and thus reduce your estate taxation. This may or may not be necessary depending on the value of your estate. There is an estate tax exemption, and it was $3.5 million in 2009. As long as the value of your estate is less than this, you don’t owe estate taxes. However, unless Congress does something it will roll back to only $1 million in 2011.

Jim H

November 15th, 2010
3:43 pm

Correction. If the estate is the beneficiary it can be taxed and if an individual is the beneficiary it will not be taxed.

Stu

November 15th, 2010
3:47 pm

A word to the wise, don’t fib about whether you smoke, or have smoked, on a life insurance application. Acquaintance of mine did that. After he died his insurer refused to honor the policy when they discovered he’d been a smoker. It wound up in court and was a huge hassle for his widow.

Jim H

November 15th, 2010
3:49 pm

Stu, the insurer only has two years after the policy’s inception to discover any mistruths.

Get the Facts

November 15th, 2010
4:01 pm

I am a Financial Advisor who owns whole life insurance on myself. The majority of my life insurance is whole life. You need to understand what the real market rate of return is and how all the pieces fit together. Don’t listen to advisors who tell you NEVER purchase a certain product. Everyone’s situation is different and unique. I cringe when I see articles by others in my industry who make such definitive incorrect statements.

Woody

November 15th, 2010
4:02 pm

I think it’s great the way you broke this down with simple rules to follow. I know im constantly bombarded by sales people trying to sell me variable policies and annuities. Seems you have made it clear that this is rarely, if ever advisable.

Get the Facts

November 15th, 2010
4:03 pm

Mr. Moss:
Why don’t you tell us what your personal financial plan contains and what you do? Do you own or invest in the same strategies you advise your clients to implement?

Wes Moss

November 15th, 2010
4:08 pm

We will have to wait and see what congress does on the estate tax. This year (2010) there is no estate tax, but next year (2011) the estate tax exclusion is set to revert back to $1 million per individual (unless congress passes legislation to up the amount). Regardless of what they do in Washington, if you have a net worth of greater than $1.0 million it makes sense to seek the council of an estate planning attorney.

Tech82

November 15th, 2010
4:14 pm

Jim H – You are incorrect. Life insurance proceeds are INCOME tax free but a policy owned by the decedent is part of the decedent’s estate whether the estate was the beneficiary or not.

hdhd

November 15th, 2010
4:16 pm

Maybe it should have read “never buy whole life unless you plan on being financially unstable and have little net worth at the end of the term” because then whole life would be an OK idea.

From an agent

November 15th, 2010
4:21 pm

Don’t listen to what this guy or Clark Howard has to say about insurance. Needs are different for everyone. Sit down with an independent agent who has 5 years experience and let them help you decide which plans are best. Term is good if you plan on not having a need for insurance at the end of it but should you have that need, costs are based on the age attained. Also, the concept of pay less and invest the rest only works on the ones diciplined to do so.

From an agent

November 15th, 2010
4:22 pm

Also, there is no such thing as mortgage insurance any longer. This went out about 15 years ago.

Bacchus

November 15th, 2010
4:47 pm

I stand with the “ask a professional” crowd. Find a trusted fee-charging CFP with whom you can discuss your situation. Shopping around on the internet will just yield a cheap solution full of holes that benefits nobody but the people who sold it to you.

Personally I’ve got a mix of term and whole life and I’m late 20s and single. Consider the level-premium option while purchasing a policy. You’ll pay a fixed premium as you get older rather than one that increases as you get older and, well, more likely to need it.

Get it when you’re young and its cheap; get it later (after marriage, after kids, and after you develop a health history) and you will pay a LOT more.

aj

November 15th, 2010
4:52 pm

Whole Life is a waste? Right…why not ask that person who hooked on a 20 year term back in 1991 and ask them how that worked out for them. Whole Life is more expensive, but at the end of 20 years you at least have something to show for it. It’s a safe place to put your money, but no you’re not going to see much more than 4 or 5 percent growth. That being said, it can do many things for your retirement that a 401k can’t. I’d say the smart play is a blend of both Whole Life and 401k…

34 yrs of selling the stuff

November 15th, 2010
5:04 pm

There are a class of policies that haven’t yet been mentioned. They fall in between Whole life and Term. They can basically GUARANTEE the coverage for life (instead of a short term period) but do not carry the extra costs inherent in policies that PROJECT to build cash values. Some call them “term for life”, and for permanent needs, it’s what we recommend …. I’ve just seen too many PROJECTIONS made over the last 34 years that never came true … so if it’s not GUARANTEED, I simply don’t trust it any more.

By the way – whether a policie’s death benefit is includable in a taxable estate has nothing to do with who the beneficiary is … it’s all who OWNS the policy …

34 yrs of selling the stuff

November 15th, 2010
5:14 pm

Jim H is dangerous ….

Nearly 31 years

November 15th, 2010
5:51 pm

“Get The Facts” and ‘34 years of selling the stuff” have it correct! I have nearly 31 years in the business of which the first 15 were spent selling life insurance. I also hold the same designation as the author of this article plus three other professional designations. The author is WRONG, and I will be happy to debate him on his advice–anywhere and any place. I have both types of insurance. There is a time and place for both types of these coverage plus add in the guaranteed ul. One needs to determine what the client wants before determining any recommendation. A recommendation needs to be based on the clients desires and financial situation before flat out recommending something. Also 18x for needs does not fit all. The only correct way is to capitalize an amount based on a conservative rate of return plus add in other needed amounts for debt liquidation, mortgage, education etc.

Michael

November 15th, 2010
6:04 pm

Like anything else in life, if you are not sure, ask a professional. I assume that Mr. Moss is a financial planner and not an insurance agent. Taking insurance advise from him is like taking plumbing advise from a contractor. While he may have some experience dealing with insurance, he is not an expert. Insurance is a PART of your financial plan. You should talk with a licensed, experienced insurance agent to determine your needs. Term insurance is great for some situations. For others, a Universal life or Whole life policy may be the best fit.
In the matter of “don’t buy mortgage life insurance, it only protects the mortgage company”, that may not be the case. I am an insurance agent and what I sell 99% of the time is Mortgage Protection insurance. This can be either term or universal life coverage. It pays the death benefit to the insured’s beneficiary, NOT to the mortgage company. In the event of major illness, sickness, injury or other such conditions, this type of policy gives you access to your death benefit in your time of financial need to help prevent medical bills from piling up and you being unable to pay your mortgage.
While I usually agree with much of what Mr. Moss says, in this case, I think talking to a licensed insurance agent to get all of your options is a wise move.

Michael

November 15th, 2010
6:08 pm

One last thing. When I hear someone give the advice like Mr. Moss gives here by saying this is what you need and other things are no good, it reminds me of the following saying that applies in the medical community: “Prescription without proper diagnosis leads to malpractice”. By saying what someone needs without getting all of the information may lead to bad results.

Wes Moss

November 15th, 2010
6:35 pm

This has been a great back and forth today…exactly what a blog is designed to do! As everyone can see, there are numerous ways to look at insurance planning, investment planning, etc…that’s why it makes sense to sit down with someone you trust that will give you an objective OPINION on what might work best for you and your family.

Jim H

November 16th, 2010
9:38 am

34 years, I am not dangerous. I sell the best product to fit a need. You should change your name to “34 years of not paying attention”.

Jim H

November 16th, 2010
9:40 am

Additionally, most of my clients are well off or will be within the next 30 years, so whole life does not make sense. Next time you criticize me you should think twice.

Jim H

November 16th, 2010
9:51 am

Here you are 34 years: http://www.wwwebtax.com/income/life_insurance_proceeds.htm

34 years of learning nothing!

Jim H

November 16th, 2010
9:59 am

Now if you surrender a whole life policy for cash then it is a different story as for taxes.

34 yrs of selling the stuff

November 17th, 2010
5:56 pm

Jim H … ever consider that there many different types of taxes – besides INCOME taxes?

Be careful out there …