Life insurance isn't something people like to talk about, especially young people. After all, thinking about dying and what happens to family or loved ones after you're gone isn't the easiest thing to do.
When you purchase a life insurance policy, you're agreeing to pay a regular premium, or fee, often on a monthly or quarterly basis. In return, the insurance company agrees to pay a death benefit of a certain value to your beneficiaries if you die. Most people designate their spouses, partners, or children as beneficiaries, but you can choose anyone you want, such as a parent or a business partner.
So how large a policy do you need? There's no set amount. One rule of thumb says that you should have insurance that's five to seven times your annual salary, while another says ten times your salary is appropriate. One thing is for sure, though: If you're like most young people, you have financial obligations like mortgages and children's tuition ahead of you. So you'll need more insurance than older people who've already paid off those kinds of expenses.
The first question to ask yourself about life insurance is whether you need it. If you're married or if you have children, then you definitely do. It's the only sure way to provide income for your family's financial needs, from funeral expenses to mortgages and education costs.
If you don't have a spouse or kids, or if you're planning to stay single, and there's no one else that depends on you for financial support, then you probably don't need insurance. If you die and leave debts behind, your creditors can try to collect from your estate. But they can't collect from your parents or other people unless those people cosigned the loan agreement.
Even if you know you should be covered by insurance, it can be even more tempting to put off getting coverage than it is to put off investing. And it's easy to find reasons why there's no rush. Here are some common excuses and why they don't stand up.
You're covered through your job. Most employer-based policies are relatively small if they're offered at all, and they end when you leave the company.
You have an accidental death insurance policy. While you have a greater chance of dying in an accident before you're 35 than after, there are still other ways to die. And accidental death policies often come with strings attached. A regular term or whole life policy will give you much more effective coverage.
You bought coverage through a credit card company or your bank. Offers for life insurance that come with your monthly credit card or bank statement can seem appealing — especially since they're convenient and cheap. But they're not always good coverage. Make sure you know what you're buying before you spend money on an offer like this.
There are two main types of life insurance: term insurance and whole life insurance. As the name suggests, a term policy covers you for a set period of time, usually 5, 10, 15, or 20 years. Then you must renew it.
Since term insurance is much cheaper than whole life, many financial experts recommend it for young people. The limited time frame can be good, too, since it gives you the chance to switch over to a whole life policy in the future, if you choose to.
Other advisers suggest you might want to purchase a whole life policy right away. In addition to providing coverage for life, these policies set aside a portion of each premium payment to accumulate as tax-free savings. You can even use these tax-free dollars to pay your premiums on some policies. To help sort out your questions, it may be smart to talk to a fee-only insurance consultant who can explain the pros and cons of each type of insurance. What you need is a neutral perspective.
Even though whole life insurance provides tax-free savings, just as some types of investments do, that doesn't mean that the two things serve the same purpose. Many people make the mistake of thinking that they can provide financial security for their loved ones just by investing. Or they think that they can use the value that builds up in their insurance policy to support themselves in retirement instead of using investments and other savings.
A financial plan that omits insurance or investments can be a dangerous proposition. You run the risk of leaving your loved ones with financial burdens if you die, or of not having the money to retire the way you want, or both. To have a secure financial strategy, you should consider both insurance and investments.