There are many good reasons to consider buying a life insurance policy, such as a recent marriage, a new baby, or taking on a large debt (like a house) loved ones would have trouble paying off if something happened to you. Or, perhaps you have witnessed first-hand the impact a death has on surviving family members' 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.
- Life insurance can offer a measure of financial reassurance to your loved ones if something were to happen to you.
- The younger and healthier you are when buying life insurance, the lower your premiums are likely to be.
- It's important to compare various types of life insurance to find the policy that's right for you and your financial situation.
- It's possible to own more than one life insurance policy, though you may be required to complete a medical exam to qualify for each one.
Mistake #1 — Waiting to Buy Insurance
When purchasing life insurance, it's important to consider the amount of coverage you need as well as the cost. Life insurance premiums are based on a number of factors, including your age and overall health.
Buying a life insurance policy sooner, rather than later, can work in your favor if you're hoping to secure a policy at the lowest possible cost. 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.
In addition to completing a health questionnaire, you may be required to complete a paramedical exam as part of the life insurance underwriting process.
Mistake #2 — Buying the Cheapest Policy
While it is important to shop for a policy that's affordably priced, it's important to consider what you're getting in return, in terms of coverage. Life insurance policies can be a bit complicated, so it's a good idea to learn about their features and benefits.
For example, term life insurance tends to be cheaper than permanent life insurance. But there's a caveat: term life insurance only covers you for a set time period while permanent life insurance can cover you until death, as long as your premiums are paid.
If you believe you'll only need life insurance for a set period, say 20 or 30 years, then a term life policy can be an affordable option. On the other hand, if you're interested in lifetime coverage or you want to own a life insurance policy that builds cash value as an investment vehicle, then it could be worth it to pay more in premiums for permanent coverage.
If you buy a term life insurance policy then later decide you want lifetime coverage, you may be able to convert your existing policy to permanent life insurance.
Mistake #3 — Allowing Premiums to Lapse
When purchasing life insurance, you're expected to pay a premium in return for coverage. Again, these premiums can be based on your insurance risk class, which correlates to your age, health and other factors. 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 impact the 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 payment is late or missed, which could be problematic if you live longer.
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 #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 in various investments similar to mutual funds that 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.
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 #5 — Borrowing From Your Policy
Permanent life insurance policies that accumulate cash value could be a source of funds when you need to borrow money. 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. Not to mention, you may significantly reduce the death benefit that's available to your beneficiaries when you pass away.
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 to avoid any unwanted tax liability.
Taking a life insurance loan is different from tapping policy benefits prematurely through an accelerated death benefit rider.
Can You Have Multiple Life Insurance Policies?
There's no rule issued by life insurance companies that disallows you from owning multiple life insurance policies. And there are some scenarios where it may make sense to do so.
For instance, you may have purchased a $250,000 term life policy at age 30, only to decide at age 40 that you need more coverage. You may choose to purchase a second $250,000 term life policy to close any gaps in your financial plan. Or, you may opt to own both a term life policy and a permanent life insurance policy.
There are some things to keep in mind about owning multiple life insurance policies, however. First, multiple policies mean multiple premiums. If you're purchasing different policies at different times, you may see a wide range between the highest and lowest premiums, depending on your age and health.
Applying for multiple policies may also mean having to submit to multiple paramedical exams. These exams are conducted as part of the underwriting process and typically involve submitting blood and during samples, as well as having your blood pressure and other vitals checked. While these exams are usually brief, scheduling several of them may be inconvenient.
Keeping up with multiple policies can also complicate things, especially if you're using several permanent life policies as an investment tool. It could increase the odds of overlooking a premium due date, which could cause one of your policies to lapse.
Consider talking to your insurance agent or financial advisor about the pros and cons of owning multiple life insurance policies and what tax implications that might have, if any.
The Bottom Line
The decision to buy life insurance is an important one. Before committing to a policy, make sure you do your homework, read your insurance contract carefully and understand all of its provisions. While losing or never buying life insurance may not ruin your life, it will certainly hurt the people you're buying it to protect.