Once you have decided to purchase life insurance, you need to think about what kind of insurance to buy and how the coverage should be designed to best meet your needs. Everybody has a different financial situation, and here are some essential issues to consider:
How Long Do You Need the Coverage to Last?
If you have a defined period of time during which you want to have coverage, then either term or permanent life insurance could be appropriate. Term policies can be purchased with guaranteed level premiums for 10, 15, 20 or 30 years. But once the guarantee period ends, the premium can become very expensive. If you anticipate needing coverage for more than 30 years or for your entire life, then you should consider permanent insurance. (See also: Understanding Different Types of Life Insurance.)
For many people, the need for coverage decreases over time, for example as debts are paid off and children graduate college. One strategy is buying a combination of policies. For example, you need $1 million in total coverage and buy a $250,000 10-year, a $250,000 20-year and a $500,000 of 30-year term policies. If you find you need less coverage than expected, you can decrease the face amount on the 30-year policy or allow it to lapse. But if things don’t work out as planned, having purchased a term policy with a conversion option guarantees you will always have affordable coverage for as long as necessary.(See also: Why buy life insurance with a conversion option)
Should You Buy a Disability Waiver of Premium?
Adding a disability waiver of premium rider to a life insurance policy is an expensive way to get limited coverage. Before buying a disability waiver:
- If you do not have long-term disability insurance, you should look into buying an individual policy, if available.
- If you do have group and/or individual coverage, first evaluate how much after-tax income you will receive. If it is not enough income to meet your needs, then check to see if you are eligible to purchase any additional individual coverage. Also, consider what could happen if you change or lose your job and the disability benefit.
Disability riders vary by insurer and policy, so it is important to understand exactly what benefit you will receive and how it will affect the coverage. Some waivers cover only the cost of insurance, while others replace the entire premium allowing the cash value in a permanent policy to keep growing. (See also: Let Life Insurance Riders Drive Your Coverage.)
Do You Want a Guaranteed Policy?
Only term, no lapse universal life and some whole life policies have guaranteed premiums and death benefits. In most other permanent policies, the premium is based on a number of assumptions that include an assumed rate of return. That means you as the policy owner are accepting investment risk, and if the policy underperforms, you could be forced to pay a higher premium. So it is important to understand where you want to have risk and where you want guarantees in your financial life.
What to Do If You Have Health Issues or Are Rated?
If you apply for insurance, and the insurer offers a policy with a rating, you should work with an insurance broker to shop the coverage among several companies. Insurers rate medical issues differently. Also, if you applied for term, consider instead buying a permanent life insurance policy. Many companies, especially towards the end of calendar year when they are trying to meet goals, offer a table shaving program in which they will, for example, move you up from a Table 3 to Table 1 rating. This can significantly reduce the cost of insurance
How Should the Policy Be Owned?
If you own or your revocable trust own a life insurance policy, the death benefit will be included in your gross taxable estate. You may not owe federal estate taxes if your estate is less than $5,450,000 in 2016. However, some states levy taxes on estates valued at $1 million dollars or less. If you reside in a state where your estate could be taxed, you should consider having the policy owned by a spouse or an irrevocable life insurance trust (ILIT). Also, be aware of that policies you own that are transferred to an ILIT and subject to a three-year lookback rule.
Should You Buy a Policy That Builds Cash Value?
Most people buy life insurance for the leverage. They want to pay a small premium to get a large death benefit. Unless you have a specific need for permanent coverage, such as estate planning or funding a special needs trust, it makes sense to first buy a term policy with a conversion rider and fully fund all your qualified retirement plan and IRA options. Then, if you have the cash flow and are ready to commit the funds for a long period of time, it could make sense to buy a permanent life insurance policy.
Level, Increasing or Decreasing Death Benefit
Term life insurance policies offer only a level death benefit. Permanent policies allow you to elect a level or increasing death benefit. For example, if you have a $250,000 policy with a $20,000 cash value and a level death benefit, you have only $230,000 of insurance, since the death benefit will include your $20,000. With an increasing death benefit you are buying more insurance, so the payment would be $270,000 ($250,000 plus $20,000).
Many policies allow you to switch between the level and increasing option so you can adjust your coverage depending on your need. Also, both permanent and term policies, within limits, allow you to decrease the face amount of coverage without underwriting. To increase coverage once a policy has been issued usually requires underwriting.
The Bottom Line
Your life insurance coverage should be tailored to meet your individual financial situation. And you should not be reluctant to ask the insurance broker a lot of questions about different policies and design options.