Things to Consider when Replacing a Life Insurance Policy
Over the past few posts, I’ve been talking a lot about insurance, specifically life insurance. In the last two posts, I’ve discussed the process we used to buy new life insurance policies and then discussed why we decided to cash in our variable adjustable life policies and replace them with term policies . Though I recommend buying term life insurance, I would be remiss to not discuss some of the concerns to be aware of if you decide to replace your current policy. (I would also be remiss to have any more posts concerning life insurance in the near future!)
Be cautious when replacing life insurance coverage
If you currently have a variable or whole life insurance policy (let’s call it "cash value" today), I urge you to be very cautious when replacing your existing coverage.
The first and most important rule when replacing your current coverage, term or cash value, is do not cancel your current policy until you are sure your new policy is in effect . This is absolutely critical - you can’t afford to have something untoward happen after you’ve canceled your policy but before your new one is in effect. Or, what if you cancel your current policy and your application for new coverage is rejected? For someone who needs life insurance, expensive coverage is much better than no coverage at all! Please, proceed slowly and cautiously when doing this.
Your current policy may have surrender charges
If you haven’t had your cash value coverage very long, you might have to pay a surrender charge to free your money. Yes, you may have to pay the insurance company more of your money to take out your money. Of course, since almost 100% of the premiums go to the insurance company the first year or so, you might not have much money to take out anyway.
Make sure a new policy is cost-effective
On the other hand, if you’ve had your policy a long time, even a new term policy might be just as expensive as your current policy. This is especially true if you’ve developed health issues or started smoking (or took up sky-diving) in the meantime.
But on the other hand (that’s 3 now?), insurance rates have gone down quite a bit in the last few years, so it might be worth it to check out the current rates. You might be able to save a significant amount of money, especially if you’ve improved your health by quitting smoking or losing weight (or stopped sky-diving)
Two miscellaneous words of caution
Remember that most insurance policies have an exclusion period during which they won’t pay the death benefit under certain circumstances. For instance, on my new policy, they will not pay the death benefit if I commit suicide within the first two years. Also, if they determine that I lied about something on my application, they won’t pay out if I die within the first two years and the thing I lied about contributes to my demise. (don’t lie and don’t commit suicide and you can ignore this warning - you know, that’s just two real good pieces of advice for everyday living right there)
Also, when choosing a replacement term policy, remember that the insurance company still has to be around in 25 years or whatever to pay out the death benefit if you die while you have the policy. So, don’t scrimp too much and get a unstable company just to save a little money each year. (Of course, in the current economic climate it is very difficult to determine which companies, if any, are stable…but do your best) Check out ambest.com to get the current ratings of insurance companies - you do have to register to see their ratings but registration is free.
Talk to someone
If you are considering replacing your cash value policy, my advice would be to talk to a professional or someone with a lot of experience in this area to see what makes sense for you. Of course, talk to someone who will have your best interests in mind and not just his/her commission check. Whatever you do, don’t let him/her churn you into another expensive cash value policy that will trigger another set of surrender charges and crazy first year fees.
So, check out rates on insweb.com or selectquote.com and see if replacing your current coverage is worth it, then go through the entire process before doing anything with your current policy .
Photo Credits: Picture Perfect Pose and upyernozWhy We Switched to Term Life Insurance
In a previous post, I mentioned that my wife and I had recently cashed in our variable adjustable life (VAL) policies and replaced them with term life insurance policies . I’d like to take you through my thought process for deciding to take this step.
Term or Universal/Variable/Whole?
When I first started my journey to learning about personal finances, most of the books and advice I read suggested purchasing term life insurance policies and not to combine your investing and life insurance. The main reason were the onerous costs and fees typically associated with the universal policies that tend to eat into your investment results (can I just refer to universal/variable/whole/etc as "universal?" - it’s a real pain to write them all out). I also have a friend who is a financial planner and he told me that he has never recommended a universal policy for one of his clients.
The fees really are pretty crazy on these policies. For instance, during the first year almost 100% of your premiums go toward…well, I don’t know where it goes but I do know that it does not go into your investing account. After putting around $5000 into the account during the first year, I remember having a few hundred dollars in cash value! During the last few months that I owned the policy, I reduced the premium amount to $50 and that sounds like a pretty good deal. But after riders and fees, less than half of that actually made it into the investing portion of my policy. You might say, not too bad - only $30 per month for insurance? Well, sorta, this did not actually cover the cost of the coverage - each month they would take money from the cash value to fund the difference. And these policies are terribly complicated: it took me more than a few phone calls to figure out where all the money was going. At one point, the agent did not even know what some of the fees were - he had to check with the home office and call me back.
Do universal policies ever make sense?
To be fair, In limited situations and for specific purposes, it might make sense to use a universal policy. The situation of which I am speaking applies to high-income earners who have maxed out their tax-advantaged investment options and still have more money to invest. Universal policies are typically tax-deferred and present another opportunity for avoiding the tax bite. Also, your universal policy usually affords some liability protection compared to a standard taxable investing account. If this applies to you, it might work for you to over-fund a universal policy to take advantage of liability protection and tax-advantaged growth. I certainly would not recommend doing what we did though - putting less into 401k accounts and Roth IRAs so we could fund an expensive life insurance policy.
Our experience with VAL
In 2001, my wife and I both purchased VAL policies on the advice of our financial planner at the time. We owned these policies until 2007. Of course, the investments started out rough during the early 2000’s but for the past few years, a pretty good bull market had been raging. My wife paid the minimum amount in premiums while I overpaid to build up extra investing equity.
So the result when we investigated how much they worth if we cashed them in? Well, let’s look at the bright side - at least I wouldn’t have to pay any taxes on the money. That’s right, the cash value amount after six years of funding the policies, even through a bull market, was less than I had paid in premiums. So, that pretty much sealed the deal for us. Unfortunately, that left me with the nagging feeling that if we had purchased much less expensive term policies and invested the difference in a Roth IRA we would be a lot better off now (my wife has repeatedly urged me not to dwell on this).
So we decided to investigate term policies
Previously, I discussed the process that we used to investigate and purchase term life insurance policies . Well, we followed that process and ended up with much more insurance with guaranteed premiums for 20 years at a much lower cost (basically I now pay yearly for 2x the coverage what I used to pay for 2 months).
Do something constructive with the extra money
If you replace a universal policy, you may have a chunk of cash when you cancel your policy and you will probably have a monthly savings as a result of paying lower premiums. Don’t just squander this money. Even if the fees are high on the universal policy, it does act as forced savings. You would have been better off keeping the universal policy than just blowing the premium savings each month.
Personally, we used the cash value of our old policies to pay down some of our student loans. Then we used the monthly savings to accelerate the remaining loan. These two factors were actually a big part of us finally getting out of debt except for the mortgage .
Do not cancel your current policy before the replacement is in effect
That’s the most important item to remember when replacing life insurance. In my next post I will expound on the topics that should be considered when deciding whether or not to replace a life insurance policy - please check back. This one is so important, however, that I have to point it out here and now. Let me repeat: even if your policy is super expensive, do not cancel it until your new policy is fully in effect.
Parting questions…
Has anyone else switched from universal to term? Were you able to be good about using the monthly savings constructively? Has anyone gone the other way? I would be very interested to hear the reasons for that switch.
Buying Life Insurance
Last year, my wife and I bought new life insurance policies to replace our expensive universal policies. Those old policies weren’t earning me nearly as much money as I was told they would - but that’s the topic of another post. So we researched how much term life insurance policies would cost and decided it was the best decision for us to replace ours. Be aware that replacing a policy is NOT always in your best interest depending on how long you’ve had the policy and how much a replacement policy would cost.
We bought term life insurance policies
First, a disclaimer - I am a big proponent of life insurance. I think it is a very important piece of most people’s financial planning process. In fact, in my previous posts I have discussed the importance of insurance in general and the importance of life insurance for a stay-at-home spouse .
I am also a big proponent of term life insurance policies. Term policies are currently so inexpensive for most people, they can really enable you to buy sufficient protection without a huge yearly outlay. I’ve read about the different types of policies and I would maybe concede that for some very high-income earners, the more expensive whole life or universal life might be worthwhile for tax reasons. But certainly for the vast majority of us, I think term life insurance is the best value. In fact, I have a friend who has been a fee-only financial planner for many years and has never recommended that any of his clients purchase anything other than term life insurance.
First determine your life insurance need
Maybe this isn’t the best way to buy it…but I’ll take you through the process we used and hopefully that will be helpful to you. We started off our search by determining how much life insurance we wanted to purchase. There are a number of useful calculators you could use to do this, such as these at msnmoney.com or smartmoney.com . Honestly, though, they all seemed so complicated and nebulous to me (how do I know how much my wife and kids would need to live on in 20 years?), so I didn’t really use one. I just picked a huge number and used that (by huge I mean 20 times my salary - its seems like that should be enough).
You should also take into account other sources for insurance coverage as well. For instance, my company provides a little life insurance at no cost and I can also get up to 7 times my salary at very low cost. So, I took advantage of that to get very inexpensive life insurance. Be careful not to count on these employer plans for too much of your need, however. If you change jobs or lose your job you won’t have it any more (or, if you can continue it, it will probably be at a much higher price). Also, the price goes up over time and will eventually become too expensive. So, I took all of this into account and used this extra to supplement our coverage for the next few years while my kids are young. As they get older and we can build up our net worth, we’ll be able to let this employer coverage drop when its gets too expensive. Supplementing with these policies enabled us to purchase less private life insurance.
The final thing to consider with term life insurance is how long you want the guaranteed rate. I think you can purchase a policy that will not change premiums for up to 30 years. Obviously, that will cost more than a 10 year policy. So, if your mortgage will be paid off and your kids will be finished with college and out of the house in 10 years, you might not need a 30 year policy. Remember that your ultimate goal here is self-insurance and decreasing your expenses and increasing your net worth leads you there.
Start by looking online
We then turned to the internet with some online searches to get an overview on what insurance was available and how much it would cost. There are a number of popular websites to start with like insweb.com , reliaquote.com , selectquote.com , intelliquote.com . (Note that I’m not endorsing these - I found them via a search…I do think I used insweb though)
We ended up using a local agent
On some of the websites, you enter your contact information and some local agents will typically end up calling you. I took some calls and asked some questions to see if I wanted to use a local agent. I told them right away that I wanted $X of term-life insurance to see what they would say. One actually told me he wasn’t interested in working with me since if I only wanted a term policy i could just get it from any online place. I guess that’s his prerogative if he feels like its not worth his time to sell me a term policy (but what does that tell you about how lucrative for the agents those expensive policies are?)
I did agree to meet with an agent who came to my house and brought a bunch of quotes (the same quotes as I saw online so I was comfortable with them). So we filled out forms and he arranged all the medical exams and such. I felt like it was beneficial to meet face to face as he was able to answer the questions we had and we got the coverage we wanted (he didn’t even try to convince me to buy the expensive stuff). Plus, since it wasn’t any more expensive, it was nice to help out a seemingly honest local agent trying to make a living like the rest of us.
Our agent actually saved us some money too
For my wife, she was rated as preferred by the insurance company. Our agent was surprised that she did not get the absolute highest rating so he went back and talked to his contacts and determined the reason that she only got preferred. He also determined which insurance companies have different underwriting standards. He then re-submitted her application to another insurance company and we ended up saving a few hundred dollars a year as a result - that was very good bonus!
So just get some life insurance
Anyway, the main takeaway is … get life insurance. Yes, yes, determine if you need it first (you probably do). If you do, consider an inexpensive term policy and since it is so cheap, get a lot of coverage. Be cautious if you are replacing a policy - please seriously consider whether that is the best thing to do. Start your search online but also consider using a local agent who will sell you what you want, not what makes him/her the most money.
Photo Credits: Joe Howell and *clairity*Why a Stay-at-Home Spouse Needs Life Insurance
In typical single-income households, there is great emphasis placed on purchasing life insurance for the bread-winner. Of course this makes sense: what would happen to the remaining spouse and children (if there are any) if the primary income earner died?
But I’m going to post a question (and answer it too!) Does the stay-at-home spouse need life insurance as well?
Definitely Yes!
Ok, allow me to clarify that with a fancy if-then statement for those of us who love software development (really? no one else? C’mon - I’m sure The Happy Rock likes writing code)
Does a stay-at-home spouse need life insurance? I would contend that if the working spouse needs life insurance then the stay-at-home spouse probably needs it too.
If the working spouse needs life insurance, it is probably because there are kids in the picture and/or there are health issues involved. If it were just the two healthy spouses, if one died, presumably the other would find a job and continue living. (I know that’s an overly simplistic way to look at this)
So, let’s assume that there is a family with one spouse who stays at home with two small children while the other spouse works outside the house and brings in an income. Let’s use a specific example - a working father and a mom who stays at home with two little kids. Obviously if the father died, they would need a significant amount of money to continue their standard of living without mom having to go back to work and not being able to continue raising her kids.
But what about all that the stay at home spouse does?
But remember that both spouses have certain roles and responsibilities that would need to be filled if they were not around to do them. It’s easy to see what would need to be replaced if dad was no longer around to provide the income, but think of all the things that the mom in our example does. Who would take care of the house, provide day-to-day care for the kids, run them to various activities, and so on and so forth if she were no longer around? It would be tremendously expensive for the father to pay to replace all of that. Or, what if dad wanted to stay at home and provide the same lifestyle to which his kids are accustomed? In that case, the needs would be the same as if the sole breadwinner died.
These are the reasons that life insurance is necessary even for a spouse that doesn’t "earn" any money. Though he/she is not being paid to do his/her work on a daily basis, he/she is still doing a lot of work! And it would be extremely expensive to hire people to replace that work.
If you do not have life insurance, please consider getting some
If you are a stay-at-home spouse and don’t have life insurance (or have a stay-at-home spouse that doesn’t have any), I would urge you to check into it. Term insurance is really cheap nowadays, especially for young and healthy people. I would suggest that you look into buying a term policy for 10 or 20 years depending on the age of your kids (if you have any). Even if you have small kids, after 10 or 20 years, they wont need the same level of care and you may not need as much life insurance then. (plus, I’m sure you’ll have done a great job of saving over those years and will be closer to self-insurance anyway!)
Photo Credits: Frazzled Jen and Ashok BalasubramanianTalking about Insurance is Boring! (but Necessary)
In the Personal Finance Basics series I’ve (very slowly) been working through, it is now time to talk about insurance. So, what is insurance? (it’s boring! - well, ok, that might be true, but that’s not what I mean here). I mean, what is the definition of insurance? Actually, I don’t mean that either. I mean what does insurance accomplish? I think it makes sense to think of it as a transference of risk.
Insurance is a transference of risk
In exchange for a small amount of money, the insurance company will give you a large amount of money in the rare case that you need it. You are therefore transferring the risk of having to pay a large amount of money to the insurance company. I think this definition works well for most types of insurance, but not perfectly. For instance, it does not apply strictly to most health insurance plans in the US since we want our insurance to cover all office visits and procedures, not just the very expensive and rare ones (though it does do that also)
Do I really need insurance?
Determining whether or not you need a certain type of insurance is a very important first step. Each person’s individual circumstances will determine which types of insurance are necessary. You should discuss this with a qualified professional and/or a trusted person (or persons) who can give you good counsel.
The least expensive (at least in the short-term) form of insurance is always self-insurance (I mean no insurance). Of course, if you end up needing the insurance payment, then self-insurance becomes significantly more expensive. But if you can afford the payment if the risk is realized, then you don’t need to purchase insurance. For instance, if you have the money to rebuild your house (and replace everything in it) if it burns down, you don’t need homeowner’s insurance. If you can afford to lose a lawsuit, you don’t need an umbrella policy. If your family can afford to continue their current standard of living if you die, then you don’t need life insurance. If you can’t afford any of these, however, then insurance is a good idea (a very good idea)
Again, each person has reasons for whether or not they need a certain type of insurance - there is no one size fits all answer to this question. I’m listing some common insurances that you should consider - it doesn’t mean you should buy them all (I don’t currently own all these types) nor does it mean there aren’t more that you should consider.
Common types of insurance
- Health - At the very least, you should have a major medical policy that will pay for expenses like surgeries or serious illnesses that can quickly generate enormous bills for you. Even if you have to pay for office visits ($) out of pocket, the risk of a huge hospital bill ($$$$$) is too much to ignore.
- Home Owner’s or Renter’s - These policies pay for rebuilding or repairing your house and/or your personal belongings in case of a disaster such as a fire or robbery. Having such a policy is a very good idea for almost everyone (and most mortgage companies will require one). Just note that some disasters, such as floods or earthquakes, are not typically covered under home owner’s policies. Also, look for a policy that provides "replacement cost" for your items.
- Auto - Auto insurance is mandatory in most places in the US, I believe. Even if it was not, it is still a good idea for everyone who drives. Not only do most policies provide payments to cover damage to your car and other cars in an accident, they also cover liability issues that may result.
- Personal Liability (Umbrella Policy) - If you want to ensure you are very well protected, purchase a personal liability policy. This policy acts like an "umbrella" to cover your liability over and above that which is provided by your auto and home owner’s insurance. As Dave Ramsey says, the best way to protect your assets in the case of a liability suit is to put a big, fat, ugly insurance company between you and the other party.
- Disability Insurance - The greatest asset that most people will have in their lifetime is their ability to earn an income. Disability insurance is what protects this asset. If you are unable to work, disability income will replace some or most of your income. There are two flavors, short and long term. Long-term is extremely important if you were to suffer some sort of debilitating injury or illness and not be able to work for years. The best (and most expensive) type is "own occupation" insurance. It means the insurance company will pay-out as long as you are unable to work in your current occupation. In other words, if you have a professional job, they are not going to force you to get a job at McDonald’s and stop paying you benefits. On the other hand, if your job entails sitting in an office in front of a computer (like mine does), if you can’t do that there’s a pretty small chance there would be some other kind of job they could make you do.
- Long-term care - Long-term care insurance pays for care in the event that you can no longer care for yourself. Due to the enormous (and ever-rising) costs of long-term care (in a competent facility), LTC is probably a good idea for most people. Though inexpensive for young people, the recommendations I’ve seen are to wait until between the ages of 50-60 to get a policy. There are a lot of options and policy types for long-term care - too many to go into any detail in this post.
- Life - Life insurance is very necessary for some people and quite unnecessary for others. If you are single and have enough money for a proper funeral, you don’t have much need for life insurance. Likewise, if you are married with no (or grown) children and a large enough net-worth for your spouse to continue his/her current lifestyle, again you don’t have much need for life insurance. On the other hand, if you are the sole breadwinner of a family with a few small kids, your needs are enormous. I’ve heard that the general rule of thumb for life insurance is seven times your annual salary - but personally, I think that the actual need varies greatly by your specific situation. There are numerous life insurance needs calculators you can find online. If you need life insurance, my advice to you would be to get a 20 or 30-year term-policy and get a lot of coverage (term policies are very inexpensive, so load up on the coverage).
Of course, there are many other types of insurance out there (but I’m already over 1100 words on this post) but I feel these are the most common that are needed by most people. Would you suggest any other types for most people to consider?
Photo Credits: NIOSH-
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