How to Buy Life Insurance

by Gary Foreman

Dear Gary,
Just read your info on credit life insurance "are you paying too much for insurance?" I'm looking for info on the best way to shop for fair rates on life insurance.

Dan asks a question that most of us have faced in our adult lives. And it's a question that has become more difficult to answer with the introduction of new life insurance products. Deciding where to find the cheapest rates is only part of the solution to finding the best deal on life insurance.

Lets begin with need. How much insurance should you buy? Consultants generally advise between five and seven times your before tax salary. But that's only a guideline. The best way is to estimate your survivors expenses if you die. You'll want to make sure that there's enough money to pay any debts and burial expenses. There might be some medical expenses, too.

Your spouse shouldn't have to make immediate decisions about selling your home. Think about what responsibilities the insured has around the house. Will you be needing to pay for day care now? Is the insured a do-it-yourselfer? Someone will have to be paid to do those home repairs.

Don't over insure. Many younger people without children need very little insurance. 'Empty Nesters' may also be in a position where they need just enough coverage to pay for final expenses and provide their surviving spouse with enough money so that they can avoid major financial decisions for a year or so.

A real quick way to determine the amount of coverage you need is to total up the expenses that your family will have after you're gone. First, the one time expenses at death and then the ongoing ones. Take the ongoing expenses and divide by .07. What that says is that you'll want a lump sum of money earning about 7% each year to pay those annual expenses. Add to that lump sum the amount you'll need to cover the one time expenses. The total should approximate the amount of life insurance you need.

Now that we have an idea of how much to buy we get to answer the question of what kind to buy. Here's where it gets tricky. It used to be that you bought a specific amount of insurance for a set period of time by paying a known premium. This is called 'term insurance'. Typically you'll be covered for say $500,000 for one year by paying a $600 premium.

Term insurance is simple. It's also the lowest cost insurance when you're young. But it does have some drawbacks. The first problem is that it will cost more to buy the same insurance as you get older. That only makes sense. Each year the odds go up that you'll die and your Dearly Beloved will collect from the insurance company.

The second drawback is that there's no guarantee that you can buy insurance next year. Suppose you have a heart attack. The insurance company could decide not to renew your policy or to increase your premium dramatically. The solution is to buy 'guaranteed renewable term' insurance. For higher premium your insurance company guarantees that they'll renew your policy at specific rates for a specific number of years. Typically you'll find renewal periods of from 10 to 20 years. So even if you're hanging on to life by the thinnest of threads at renewal time, you'll be able to keep your insurance.

Many younger people favor term insurance during their 20's and 30's. After all it is cheaper. But as you get nearer to forty you'll probably want to consider 'permanent insurance'. With this type of insurance, as long as you continue to pay the premiums you'll have coverage no matter what your health condition.

Permanent insurance goes by a variety of names. Basically, they're all variations on the same policy. One of the most common is called 'whole life'. Here you'll pay a consistent premium for the rest of your life. The premium is split into two parts. One part actually pays for the life insurance for that year. The other part is invested in the early years and can be used to pay your premium in later years.

In some policies you'll be given a choice of where to invest the money. You be able to choose either a fixed rate investment (like your savings account) or a variable rate investment (like a stock mutual fund). Policies that earn a variable rate are sometimes called 'universal life' insurance.

You'll find no lack of variety available. The choices are almost endless. One popular option allows you to 'borrow' the accumulated investment from the policy. This can come in handy for college tuition or other major known expenses where it's nice to begin saving a little bit on a regular basis.

Selecting an insurance company can also be challenging. According to industry sources there are over 2,000 companies that sell life insurance in the United States and Canada. Prices vary significantly. I ran a comparison of a 10 year renewable term for myself and found rates from $535 to $3,814 for a yearly premium!

But there's more than price to consider. Make sure you select a company with a high rating. Independent rating agencies do the homework. You just need to ask your agent what the company's rating is.

Your agent should also be selected carefully. They must be licensed in your state. You'll want to find out if they've taken any special training. Be clear in telling your agent what you expect them to do for you. Now's not the time to be bashful.

Finally, a word about illustrations. In all probability your agent will be showing you charts and graphs that purport to tell you what's likely to happen to your premiums, investment accounts and loan values in the future. If you look carefully you'll find a disclaimer that says that they're not guaranteeing the numbers you see. Ask your agent to run a second illustration that uses the highest allowable premium and the minimum investment results guaranteed. That way you'll see the worst case projection. The real future should be between your illustration and the one your agent ran.

When you get right down to it there's only three good things to say about shopping for life insurance. First, it's available to cover our needs. Second, we can select a plan that meets our needs. And finally, it's not something that you have to buy each year!

Gary Foreman

Gary Foreman is a former financial planner and purchasing manager who founded The Dollar website and newsletters in 1996. He's the author of How to Conquer Debt No Matter How Much You Have and he's been featured in MSN Money, Yahoo Finance, Fox Business, The Nightly Business Report, US News Money, and Gary shares his philosophy of money here. Gary is available for audio, video or print interviews. For more info see his media page.

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