What three ideas are critical to keep in mind when deciding how much life insurance you need?
For Generation X (anyone born between 1965 and 1980), you may need more than you think.
To find out if you should increase your coverage, consider these tips.
1. Work coverage is not enough. Relying on group life insurance to be your personal life insurance foundation could be a very costly mistake to both you and your heirs.
Here’s why: Group life insurance is typically capped to the amount of coverage that you can have, primarily due to the limited amount of underwriting being done today.
As a result, the insurance company has to find a way to mitigate the lack of underwriting scrutiny, and they do that in three different ways:
- First, they limit the amount of coverage that you can have.
- Second, they increase your rates every five years (typically), so though cheap early on, it becomes very expensive later on.
- And finally, they typically charge more if you are younger and in average health or better to offset those in the group who are older and in worse health.
Think of it as a seesaw.
The 50-year-old, obese, chain-smoking diabetic sitting on one side is being charged the same rate as his or her 50-year-old counterpart who runs marathons and has no body fat.
To keep the seesaw in balance, clearly the insurance company is over-charging the healthy employee to offset for under-charging the unhealthy employee.
Further complicating this is the fact that when you leave a job, your work coverage typically ends, or the policy has to be converted to an individual permanent policy at a substantially higher rate.
2. Coverage isn’t as expensive as you think. A 45-year-old man can purchase a $500,000 20-year term for $52 per month. That rate and face amount is guaranteed not to change for the next 20 years. The ads on the radio are right: Life insurance rates have come down and the premiums are not that expensive. But if you wait and purchase that same policy at age 50, the rate is now $80 per month—an increase of over 50 percent.
3. You need to protect your home and family. In today’s society of two-income families, the need for life insurance is more critical than ever. So often people think that if they pay off their mortgage, the surviving spouse should be able to make it.
But unless your income is equal to your mortgage, the surviving spouse is still losing money.
Consider this scenario, in which Adam and Eve both make $50,000 per year and buy a home with a $200,000 mortgage.
- Under the old approach—purchasing a life-insurance policy equal to the mortgage—they would typically buy a $200,000 term policy.
- Under the income approach described above: After taxes, Adam makes about $40,000 per year. Yet, there is a cost of living of having Adam around, so let’s say that calculates to about $15,000 annually (accounting for food, utilities, insurances, cars, vacations, etc.).
- So with Adam’s death, the loss of income to Eve is $25,000 per year. The amount of insurance to replace that income for the next 20 years, assuming a 7 percent investment return and 4 percent inflation, totals $386,000.
- Obviously, Eve would have to change her lifestyle if Adam had only purchased enough life insurance to pay off the mortgage. Specifically, Eve would have to reduce her expenses by $1,000 per month—even with having the mortgage paid off.
The bottom line for Gen-Xers to keep in mind: The proper insurance plan should focus on the needs of the survivor, specifically, replacing the lost income of the person who dies.
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