Benjamin Franklin once said “Certainty? In this world nothing is certain but death and taxes.” Life is full of risks. It is one thing that is certain in life. Although one cannot control death, one can control how to protect loved ones through life insurance. Here are some insurance basics to help you navigate through the maze! Insurance is one way of the four ways to deal with risk. The four are:
- Ignoring It
- Avoiding It
- Managing It
- Transferring It
Let’s say you are worried about the risk of getting into a car accident. How can you deal with that risk? You can just ignore it and hope for the best, you can try to avoid it by not driving anymore, you can try to manage it through defensive driving, or you can transfer it to someone else, in this instance an automobile insurance company.
This is usually the best way to deal with risk, which is why many types of insurance are mandatory. The most common types of insurance are: auto, home, life, health, dental, unemployment, disability, long-term care, travel, pet, renters, business, and insurance for products like cell phones.
There are actually other types of insurance and in fact, if the price is right, you can insure almost everything! Here are some interesting and weird things people have insured:
- Alien abduction insurance – Yes, people have actually purchased insurance intended to protect them from alien abduction…if they actually exist.
- Ghost abuse insurance – The Royal Falcon Hotel in Lowestoft, England purchased policies for their employees and guests to protect them from the ghosts that they believed there.
- Tongue insurance – Food critic Egon Ronay, a famous food taste tester insured his tongue, his most valuable assets for $400,000.
- Leg insurance – Betty Grable, the famous movie actress from the 1940s, was well known for her legs. Her employers didn’t want to risk of missing out on future opportunities in case anything happened to her, especially her legs, so they took out a $1 million policy on them. The Lord of the Dance star Michael Flatley took out a policy of $47 million dollars for his dancing legs, and to top it off, reportedly famous singer Mariah Carey has insured her legs for $1 billion!
- Mustache insurance – Cricket player Merv Hughes took out a $370,000 policy to insure his walrus-style mustache.
- Hand insurance – A Canadian yo-yo maker named Cheerio insured 13-year-old Harvey Lowe’s hands, who won the World Yo-Yo championships back in 1932.
- Teeth insurance – While many of us have dental insurance, British comedian Ken Dodd, who was known for his trademark buck teeth, took it to the next level by insuring his teeth for $7.4 million dollars!
- Voice insurance – Famous rock and roll singer Bruce Springsteen has a $6 million policy on his voice in case anything happens to his singing voice!
- Butt insurance – Singer Kylie Minogue has insured her butt for $5 million and singer/actress Jennifer Lopez has insured hers for $27 million.
- Smile insurance – Julia Roberts is known for her smile, and as one of her trademark assets, she has insured it for $30 million.
- Breast insurance – Playboy Playmate Holly Madison has insured her breasts for $1 million. “I thought why not?” she said in an interview. “Because if anything happened to my boobs, I’d be out for a few months and I’d probably be out a million dollars.”
- Body insurance – Since so many insure body parts, why not just insure the whole body? That is what Daniel Craig, the latest 007 Bond star has done for $9.5 million.
While the majority of us won’t ever need insurance for our body parts or other so-called assets, it is an important part of financial planning making sure you and your loved ones are taken care of if any of the risks actually occur. But when it comes to insurance, it is easy for people to get confused. Do you have the right kind? Do you have enough? Do you even need it? You face a myriad of choices and terminology for each type of insurance. To determine if you need a certain type of insurance, you want to ask these questions:
- Do I need it?
- If I do, how much?
- When should I get it?
The most common type of insurance is life insurance, intended to protect your loved ones if anything should happen to you. The first question to ask is if you need it. You can answer this question by asking “how will my family manage financially when I die?” If you are single and your parents and siblings are going to be fine, you may not need it. But if you are the sole breadwinner with your spouse and kids relying on you, it is a good idea to get a policy.
Here are the benefits of life insurance:
- Pays out cash after you die, allowing loved ones to be financially secure.
- Life insurance payments can be used to cover daily expenses, mortgage payments, outstanding loans, education, other essential expenses.
- Proceeds are tax-free!
When should you get life insurance?
Pretty much if someone depends on you. About 31% of American believe they would feel the financial impact from the death of the primary wage earner within a month of their passing:
- Married or getting married – Especially if you are the breadwinner or rely on two incomes
- A parent or about to become one – Would your spouse be able to give your children opportunities without you?
- A homeowner – Pay the mortgage
- Retired or planning for retirement – Help widows avoid financial struggles
How much life insurance do you need?
When you consider all the things that life insurance proceeds need to fund and how long the money will be needed, you begin to realize that your true need for coverage is often
10 or 15 times your gross annual income, sometimes more! These are the expenses you want to take into account
This table below will help you determine how much life insurance you may possibly need. It is a guideline and everyone will be different, but at least you have a starting place. Just follow each number from 1 to 13. For number 4, you will use Table A to get the factor, and for number 7, use Table B if you need to pay for college. I have placed an example below.
Here is an example for a family. The total income of $75,000 in the example is what your family would need, $25,000 is what the spouse earns, so $50k is what needs to be replaced. Table A helps you multiple it based on how long you will need that income for. Calculating your expenses are next, followed by the assets that you have currently saved.
Once you know how much life insurance you need, the next is what type to get. The major types of life insurance are: term, whole life, universal life and variable universal life, among others. Here are a few explanations and recommendations that can help you choose the right type:
- Term life insurance offers the most bang for your buck. This type of insurance provides protection for a specific period of time “term” and is designed for temporary circumstances. These policies have duration limit on coverage and once they expire you decide whether to renew the policy or to let the coverage end. Term is cheap, builds no cash value and can last from 10 to 30 years. Many choose the year to track how long you must pay your mortgage, or until you reach retirement.
A recent study discovered that most Americans thought a 20-year $250,000 level term life policy for a healthy 30-year-old costs about $400 a year. In reality, annual premiums run about $150. This is why the same study found that 83% of consumers forego buying life insurance because they think it is too expensive. Instead of buying more expensive, some financial planners advise to buy term, then invest the difference. Then they can self-insure their death at retirement with enough investment assets to support the surviving spouse and family.
- Makes sense when your need for coverage will disappear at some point, such as when your children graduate from college or when a debt is paid off.
- Most common term policies are for 20 years, but they can run the gamut from one-year policies to terms of 30 years or even longer. In some cases a term policy may be converted to a permanent policy
- Typically, term offers the greatest amount of coverage for the lowest initial premium and is a good choice for tight budgets – “Buy term and invest the difference.”
- Permanent life insurance typically costs more than term and you get coverage for life. It offers lifelong protection, and can accumulate cash value on a tax-deferred basis. There are several different types of permanent insurance. Permanent insurance falls into four main categories:
- Whole Life – Most common, premiums same for life, death benefit and rate of return on cash value guaranteed. For whole life insurance products, the policy builds cash value as you get older and keep paying premiums. It typically pays either a guaranteed interest rate, often 2% to 4%, or dividends based on the insurance company’s investment experience. Proponents of whole life state that it forces people to save since those that buy term and intend to invest the difference rarely do.
- Variable Life – Can potentially get higher returns but allocating fixed premiums to investment subaccounts (stocks, bonds)
- Universal Life – Flexibility of varying the amount of your premium payments. Also offers the certainty of a guaranteed minimum death benefit as long as your premiums are sufficient to sustain it. If you do not maintain the minimum, death benefit can be reduced
- Variable Universal Life – Premium payments are also adjustable, subject to the minimum needed to keep the policy in force, and you can allocate them among investment subaccounts that offer varying degrees of risk and reward
So what type of policy should you get? From a pure investment standpoint – saving for retirement, college or for capital appreciation – life insurance is the wrong tool. When you account for the actual costs of insurance, policy fees, expense ratios of the underlying funds in variable life and variable universal life, surrender charges and agent commissions, life insurance almost always underperforms an outside, well diversified, low-cost investing strategy.
Generally speaking, I believe in buying term and investing the difference. Permanent life insurance policies carry hefty surrender charges and fees when you cancel a policy. If you surrender a policy in its first 10 to 15 years, you get back less than 100% of the cash value that you put in. Permanent policies also typically pay much higher commissions than term. If your advisor is pushing you to buy one, make sure that it is in your best interest and a tool to build wealth for you, not for your advisor.
If you are leaning towards permanent policies, ones that give you the option to use the death benefit for long-term care insurance may be a better option. These hybrid products allow you the flexibility to use it for long-term care, has the benefits of cash value, and whatever left over is left for your beneficiaries.