How Much Is Too Much? Getting the Right Amount of Life Insurance Takes Research

by Louisa Downey

Online insurance quote services

Here's the easy part: Most people need life insurance. Here's the hard part: Exactly how much do you need? If you're shopping around for a policy, remember the carpenter's rule—measure twice, cut once. Buy too much and you'll be tempted to cancel your policy in a financial crunch. Buy too little and your family won't be adequately protected. Your goal is to buy a solid safety net for your family and peace of mind for yourself. Here are a few frequently asked questions to get you started.

Who needs life insurance?
If anyone is depending on your income, you need life insurance. That can be a married couple with children, someone caring for an ailing parent, even couples who need two salaries to meet monthly expenses.

Generally speaking, single people without children do not need life insurance. Insurance salespeople may tell you that by buying young, you're guaranteeing your future insurability. In other words, the longer you wait, the more likely you are to develop a "dread disease" that will make you uninsurable. Jessie, from South Dakota, a single adult with no family members, thinks her old policy was completely unnecessary: "I have plenty through my job, but wasted premiums for years on a load of term insurance. My beneficiary was a fianc� with whom I broke up! Now I don't waste money on an extra policy but count on savings to provide funeral and other expenses."

Fully half of all people who own a whole life policy cancel it in the first 10 years.

How do I arrive at an amount?
There is no one right way to calculate how much life insurance you need. Some experts advise you to buy anywhere from four times to eight times your annual income, but this method is too simplistic. Families are as different and unique as fingerprints. You only can arrive at an amount through a thorough (and somewhat time-consuming) evaluation of your financial goals, debts, investments, and lifestyle. The amount of insurance you eventually buy probably will be a compromise between what you need and what you can afford.

What expenses do I need to consider?
Start by totting up your family's short-term needs, long-term needs, and living expenses. Short-term needs include medical, hospital, and funeral expenses; fees for attorneys and personal representatives; plus any outstanding debts, taxes, and loans. Long-term needs may include your mortgage balance and college tuition for your children. "Living expenses" refers to the amount of money your survivors need to maintain their standard of living for one year.

The theory behind term is that your need for life insurance gradually decreases as you get older.

You will need to take into account your spouse's Social Security survivor's benefits, investments, and other sources of income. Also bear in mind what your beneficiaries will do with the proceeds. Will they be able to live on the interest without touching the principal, or will they need both? Don't forget inflation—it will whittle away at the buying power of your death benefit.

The complexity of this task can lead to buyer paralysis. Several online insurance quote services have useful calculators, like InsWeb's Life Insurance Needs Analyzer, that can give you a ballpark figure.

What type of policy do I need?
There are two basic types of insurance, term and cash-value. Term insurance covers you for a period of from one year to 30 years. It only pays out if you die within that term. The theory behind term is that your need for life insurance gradually decreases as you get older. By the time you retire, if you've planned properly, you should have a secure, fixed income and won't need life insurance anymore.

If anyone is depending on your income, you need life insurance.

Cash value life insurance covers you for life and comes in three basic forms: whole life, universal life, and variable life. Cash value policies have an insurance component and an investment component. The insurance company invests some of your premium, which builds cash value over time. You can borrow against that value, although any unpaid money is subtracted from the death benefit. Premiums and death benefit remain level.

Barbara, from Washington, wishes her agent had steered her toward a cash-value policy instead of term. "Now that I'm in my 40s, the cost keeps going up, plus there is no benefit to term, where whole life is a percent of the savings of the whole life insurance," she says.

Remember, the benefit of term coverage is that it is pure protection, and thus less expensive. Some people choose to invest the difference in premiums in other investments that can meet their goals.

If you can't decide, consider a term policy that allows you to convert to a cash-value policy later, or a policy with elements of both.

How much can I afford?
Remember that the main goal of life insurance is to provide protection for your family. So, buy a policy that you won't be tempted to cancel in a pinch. Term insurance is simple, reliable, and inexpensive, and is a great place to start. And thanks to competition in the insurance marketplace, it's cheaper to buy than ever before. According to InsWeb.com, a healthy, 35-year-old, nonsmoking woman can buy $100,000 worth of term insurance for around $10 a month—or the price of three mocha lattes.

Cash-value policies have much higher premiums initially. There are good reasons for buying a cash-value policy, but make sure you've provided enough coverage for your family first and that you can afford the premiums. Fully half of all people who own a whole life policy cancel it in the first 10 years.

Should I cancel my cash-value policy and buy a term policy?
Canceling your policy before you have another puts your family at risk of potential financial ruin and may be very costly. In addition, you may forfeit some or all of the cash value accrued in the policy. Before you make any changes to either a cash-value or a term policy, get sound, expert advice from both an insurance agent and a financial planner.

Is it wise to buy online?
Online insurance quote services are a good place to begin your research. They allow you to query several carriers at once and cut your legwork in half. Plus, you only get quotes from companies who are willing to insure you and who offer life insurance products.

On InsWeb.com, you fill out a questionnaire concerning your health history, lifestyle, and age. InsWeb then distributes it to representatives of companies you choose. There's no charge and no obligation to buy. Online quote services also give you an idea of the company's attitude toward customer service—an agent who contacts you in one day is probably more service-oriented than one who takes a week.

When should I use an agent?
Buying a policy through an agent has many advantages. Many people prefer to do business over a desk with someone they know, even if it costs a little more. Your insurance agent already will know a lot about your life. He or she can help you get the right amount of life insurance, explain your options, and go over the fine print of your policy. As your insurance needs change—you have another child or remarry, for example—your agent can update your policy and schedule reviews every three years to five years.

On the other hand, many insurance agents are "captive" salespeople who only sell products from one company. Just be aware that some agents receive larger commissions from selling cash-value policies and may tend to steer you in that direction, whether that's best for you or not. Ask if your credit union has an agent it would recommend.

February 18, 2002