There are many good reasons to consider buying a life insurance policy, such as a recent marriage, a new baby, or a large debt purchase (like a mortgage) that loved ones would have trouble paying if something happened to you. Or, perhaps you have witnessed first-hand the impact a death has on a surviving family's finances. If you're in the market for life insurance or have recently bought a policy, make sure you don't put your family's finances in jeopardy by making these mistakes. (Read about whether you need life insurance and if so, how much you should get in How Much Life Insurance Should You Carry?)
Mistake No.1 — Waiting to Buy Insurance
Regardless of the reason, it's important to take action as soon as you feel a policy is required. Life insurance rates generally increase as people age or their health deteriorates. And, in some cases, illnesses or health problems may make you ineligible for coverage. The longer you put off the buying decision the more the insurance will probably cost — if you can buy it at all.
Mistake No.2 — Buying the Cheapest Policy
While it is important to shop for a policy that's priced in line with the rest of the marketplace, that should not be the sole consideration in your decision-making process. Life insurance policies can be a bit complicated, so it's a good idea to learn about policy features and benefits.
Many people mistakenly believe that price is the only differentiator for term life insurance. However, there are important policy provisions that you should investigate before going with the lowest price.
Most term policies are "convertible," meaning they may be exchanged for a permanent type of life insurance policy at a later date regardless of your future health. Some policies also offer more generous conversion privileges than others. Get an understanding of how long the conversion option is available; the most generous conversion privileges are available for as long as you pay term policy premiums or to a specific age, such as 70. Also, make sure to find out if there are any restrictions on the type of policy available for purchase under the conversion privilege. Some policies offer just one type of permanent policy at conversion, while others offer several.
Mistake No.3 — Making Late or Missed Payments
If you're considering buying a universal life policy with secondary guarantees — low-premium guaranteed death benefits for life or for a specified period of time — a late payment can have an impact on policy benefits.
Universal life is a special type of permanent policy that has been marketed as having long-term guaranteed protection at the lowest possible rate — it is very different from term insurance. While many of these types of policies have cash surrender value, universal life with secondary guarantees focuses on maximizing the amount of insurance available per dollar of premium.
Some of these policies can be sensitive to the timing of premium payments. For example, if you happen to miss a monthly payment — or are more than a month late sending in your check — your guaranteed policy may no longer be guaranteed. A policy purchased with guaranteed coverage to age 100 might only provide protection to age 92 if one premium payment is late or missed. Be sure to check with your company if you think you're going to be late on a payment; many will allow 30 to 60 days without changing the policy's guarantee.
Mistake No.4 - Forgetting Insurance Is an Investment
The Financial Industry Regulatory Authority (FINRA) considers a variable life insurance policy an investment, so it is important for you to treat it as one too.
A variable life insurance policy is a permanent type of policy that provides life insurance protection with cash value. Part of the premium goes toward life insurance, and part goes into a cash value account that is invested into various mutual fund-like investments you choose. Like mutual funds, the value of these accounts fluctuates and is based on the performance of the underlying investments. People often look to these policy values in the future as a source of funds to supplement their retirement income. (To learn more, see What is variable life insurance?)
You must fund a variable life policy sufficiently to maximize its cash value growth. This means continuing to make adequate premium payments, especially during times of poor investment returns. Paying less than originally planned can have a big impact on the cash value available to you in the future. It's also important to monitor your policy's performance and periodically "rebalance" your accounts to your desired allocation, just as you would with any investment account. This will help ensure you're not taking on more risk than you had planned when you set up your account.
Mistake No.5 - Borrowing From Your Policy
The cash value of a permanent policy can generally be used for any reason you see fit, including tax-free withdrawals and loans, if done properly. This is a great benefit, but it must be carefully managed. If you take too much money out of your policy and your policy "lapses," or runs out of money, all the gains you've taken out will become taxable.
If you have taken too much money out and your policy is about to lapse, you may be able to maintain the policy by making additional premium payments, assuming you can afford them. When accessing your life insurance policy's cash value, be sure to monitor it closely and consult your tax advisor for guidance to avoid any unwanted tax liability.
The decision to buy life insurance is an important one. Make sure you do your homework, read your policy and understand all of its provisions. While losing or never buying life insurance may not ruin your life, it will certainly hurt those people who you're buying it for.