3 Common & Costly Life Insurance Mistakes

At the end of the day, life insurance is about taking care of your loved ones after you’re gone.  While it’s not easy to discuss, it’s important to purchase.

As a Certified Financial Planner®, I’ve spent a lot of time clearing up messes and confusion others have made when purchasing life insurance.

There’s no question there’s a lot of misinformation today about life insurance. My purpose with this article is to clarify three common mistakes I see others make when purchasing life insurance.

If you can manage to avoid these mistakes, you’ll be well ahead of others, when it comes to providing security for your family.

Mistake # 1 – The Wrong Amount

A general rule of thumb in the financial planning world for decades has been the 4% withdrawal rule. Essentially, you’re able to withdrawal 4% from your portfolio in the first year, and then increase the amount withdrawn by the inflation rate every year. Doing so, your savings would last about 30 years.

Well there’s much to be debated about the rule, as stock market volatility has increased, it can be useful when determining one’s life insurance needs. If using the 4% withdrawal rule, to meet the same income needs as before (assuming that’s the goal) one would need 25 times their current income rate.

So is that the end all be all? Not necessarily.

The original 4% withdrawal study was composed of someone having their funds in a tax-deferred account. There are also other problems as well:

  • It fails to take into account the beneficiaries lifespan
  • Will the beneficiary ever return to work
  • And so on…

The point is there is no perfect rule of thumb for deciding how much life insurance you need. There are too many variables in the situation.

So, how about a calculator?

Those can be better. My preferred calculator of choice is through the LIFE Foundation’s website.

No calculator is perfect but I find them a much better starting point than a general rule of thumb.

Mistake # 2 – The Wrong Reason

As dreary as it sounds, the main purpose of life insurance is for income replacement for a loved one, if you were to die.

For the majority of individuals whose income supports a family, a term life insurance policy is the safer choice.

Term is very cheap for healthy, non-smoking individuals. Obtaining a $1,000,000, 20 year policy can cost you as little as $35 to $40 a month.

While there are of course other types of policies that are useful for specific situations, such as estate planning, business planning, etc…start your search with term.

Mistake # 3 – The Wrong Person

One common mistake I see others make is purchasing life insurance for children. Going back to its purpose, life insurance is meant to replace the income of someone who was to pass.

As dreadful as losing a child could potentially be, you don’t have to replace the income.

In the same category, in a one income household, life insurance is sometimes only purchased for the working spouse.

While they should certainly have life insurance, what would happen if the spouse who stayed at home were to pass? Often, the working spouse would have to leave their job or take on additional expenses by hiring child care.

In this scenario additional income would be needed to support the family, therefore, it would make sense to purchase a life insurance policy on a non-working spouse.

 

R.J. Weiss is a Certified Financial Planner®, who specializes in individual insurance planning, at Weiss Insurance Agencies. You can follow him on Google +.

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