When Should You Purchase Life Insurance?

US News

No one wants to admit that they could die prematurely. But the last thing you want is to not have the proper life insurance policy in place should disaster strike.

Danny Kofke, a special education teacher in Jackson County, Ga., knew he needed life insurance shortly after getting married 12 years ago. He and his wife, Tracy, were planning to have children, and they wanted Tracy to be able to stay home for at least a year to raise the child. "Since we would be depending on my teacher's salary alone to get by, we took out an insurance policy for each of us," Danny Kofke says.

The couple's 10-year term life insurance policy covered them for $250,000 each, which equated to a $24.50 monthly fee per person. "It gave us both peace of mind," Danny Kofke says. "We treated it like having automobile insurance. I never want to have to use it, but it's comforting to have it there." The Kofkes, however, had to take out another 10-year term life insurance policy this year since the old one expired.

Although the length of the original policy wasn't right for their needs, the Kofkes wisely opted for a term life insurance policy over whole life insurance. The difference between whole and term--the two basic types of life insurance--is that whole is a lifelong policy with an added investment component to it, wherein you can build up cash tax-free. However, the built-in fees, commissions, and surrender charges (in the event you cancel the policy) take such a significant chunk out of your investment that most personal-finance experts agree there are better places to invest your money. Whole life insurance plans also typically carry premiums that are up to 10 times that of term insurance. Meanwhile, with term life insurance, in exchange for fixed premiums that you pay monthly, quarterly, or annually, you are covered for a set number of years and only receive death benefits.

While some life insurance agents aim to guide you toward whole life insurance over term life insurance (whole means more commission for them), term makes more sense for most people, says Tony Steuer, a life insurance consultant and author of Questions and Answers on Life Insurance: The Life Insurance Toolbox. "Term coverage is the appropriate coverage for most individuals, as their needs are for a certain term of years while their other assets accumulate, such as retirement savings," he says.

Robert Miller, president of the National Association of Insurance and Financial Advisors, agrees with Steuer that term insurance is usually the best route. "I've always believed in insuring up to the point that you need insurance," he says. "You can do that with term insurance and it comes out to be far cheaper."

Steuer recommends guaranteed level premium term insurance, where the premium is set at a fixed rate for a specific period of time. "I match the length of the term period to the anticipated period of need," he says. "For example, with a 2-year-old child and a client purchasing a 20-year guaranteed-level premium term to take care of the child, that would provide coverage until the child is 22."

There are a few select circumstances where you might be better off with whole life insurance. For example, if you have children who are handicapped and will be financially dependent on you their whole lives, you may want to consider the permanent coverage.

Americans struggling with their finances in today's downtrodden economy may think they can save money by skimping on life insurance. Approximately 30 percent of U.S. households have no life insurance coverage, according to a 2010 study conducted by LIMRA, an insurance industry research outfit. And among households with children under 18, 11 million have no coverage.

But for parents who still have children living at home, not having a life insurance policy could put their kids at risk if something were to happen to them. In the event the parents die, a life insurance policy can provide a safety net for the children to live off of.

However, if you're young, single, and don't have any dependents, Steuer advises you hold off on purchasing life insurance. "You can't predict the future. You don't necessarily know how many kids you're going to end up with, or even if you are going to get married," he says. Nonetheless, some experts recommend buying life insurance as a young single person, due to low costs and the ability to get a 30-year term that you'd have in place for when you have kids.

So you purchase a term insurance policy to cover your spouse or your kids, but then what? Once the kids grow up, most people can let the policy expire, advises Bill Wixon, a certified financial planner with Wixon Advisors in Maple Grove, Minn. "After your kids are through college, your other assets should be built up enough that you no longer need the life insurance," Wixon says.

In terms of how much life insurance you need, there are varying schools of thought. Some financial advisers say you should insure five to seven times your salary, while others will say you need more. Wixon believes a good rule of thumb is three times your income plus debt. "A lot of the life insurance salesmen use these huge factors of 15 to 20 times your income, where almost everyone needs more than $1 million," he says. "They're just doing that to sell more insurance, in my opinion."

It's hard to come up with a magic number because your needs can change from year to year. As Steuer says, "Financial planning is always a moving target."

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