By Mark Colgan, CFP®
Most commonly, life insurance is utilized as a safety net against financial hardship. In the event of an expected or unexpected death or disability, you do not want to have the added burden of financial hardship on your shoulders. The amount, type, and timing of the insurance you carry need to be tailored to your individual and family needs. Having too much insurance could cost thousands in the long term, and the implications of having none or not enough are obvious.
Here are the 7 biggest mistakes families make with life insurance policies so you can take steps to avoid them and the headaches they cause.
1. Inadequate Insurance Coverage
This is pretty self-explanatory. When determining your life insurance coverage, you should take into account your family’s unique situation, including mortgage, income, debt, final expenses, and dependents (including future education costs). If you don’t have enough coverage, you risk your loved ones facing financial stress down the road.
To determine how much coverage is best, you should consider the following:
- Is the purpose to replace lost income, pay off debts, cover taxes, or leave a financial legacy?
- If it is to replace the lost income, then how much would your beneficiary need to invest to generate an income equivalent to what was lost? Also account for how many years the income is needed. A young person may need to replace income for 30 years, whereas someone about to retire may need to cover just a few years.
- If debt is a concern, add up not just what you owe today, but consider whether you would like to cover future debt obligations like the children’s college, wedding, etc.
- Death taxes aren’t only for the uber wealthy. Upon death, if you die with money in an IRA or other qualified retirement plan, your beneficiary may be exposed to a surge in unwanted income tax. Depending on who the beneficiary is, they may be required to deplete the balance within 10 years, resulting in large withdrawals that could force them into higher tax brackets, loss of benefits, etc. Additional tax issues may arise for business and property owners.
- If you would like to leave a bequest of money to a loved one or a favorite charity, consider the advantages of doing it via life insurance.
Keep in mind that these topics require a good understanding of financial planning and the ever-changing tax code. Hence, it’s best to sit down with an expert who will take into consideration your particular situation and provide a tailored answer as to what makes the most sense for you and your family.
2. Relying Too Heavily on Employer-Provided Coverage
If you have a group life insurance policy through work, don’t assume that the coverage will always be with you. These policies are not portable, so if you are terminated or leave the employer, you are likely to lose the life insurance coverage immediately. With the large number of layoffs related to the coronavirus pandemic, many people with life insurance policies through work have lost their coverage. That’s never a good thing, but especially not in the midst of a global health crisis. That’s why it’s important to have your own policy that doesn’t lapse instead of or in addition to the group plan at work.
3. Purchasing Life Insurance From Multiple Sources
Banks offer mortgage life insurance. Airlines, car rental companies, and even credit card companies offer life policies in case you’re not around to pay the mortgage or if you die in an airplane crash or need to pay other expenses. Those policies are hugely profitable to the providers, and the insured rarely collects on them. Instead, use one trusted professional to create a portfolio of life insurance policies that are tailored to your specific needs.
4. Your Term Insurance Has Run Out or Has Become Too Expensive to Carry
If you have a low-premium term insurance policy, it’s nice to know that you are paying lower premiums for higher coverage. However, that privilege comes with a couple of trade-offs. First, you are not building any equity in the policy, meaning that when the policy term is done, you will not have anything to show for it. Also, if by chance you become ill or have medical issues at the time your policy terms out, you may not be eligible to renew your policy or obtain a new one. This results in another scenario that would leave your loved ones with an unexpected financial risk.
5. Buying Life Insurance Once and Not Reevaluating
Your life insurance needs evolve. Throughout every stage of life, circumstances change and the amount and type of life insurance you need could very well change. Additionally, insurance companies are continuously launching new products to adapt to the needs of consumers, so there may be better solutions available. A perfect example of this is life insurance with a rider that provides early access to your death benefit for the purposes of covering long-term care expenses. Generally, we recommend reevaluating your insurance needs anytime a notable milestone occurs in your life, when you see your future plans changing, or at least every five years.
6. Neglecting to Review or Update Your Life Insurance Policy
The time to review your life insurance coverage is not right after a tragic event. Many other less dramatic life changes also require another insurance review. For example, if you added another child to your family, you might want to increase coverage. If you got a new mortgage or added any other debt, your liabilities will increase and your policy should reflect that. Or maybe you’ve put your kids through college, have steadily growing savings, and have paid off the mortgage. Do you need as much coverage as you did when you had young children around and less money to spare? Any time you reach a new life milestone or experience a major change, review your coverage and update your beneficiaries. It’s also a good idea to have at least two backup beneficiaries.
7. Not Getting Financial and Legal Advice
Life insurance should be part of a comprehensive financial plan. If you have a financial planner, you should be discussing how your insurance needs fit into your financial plan before purchasing a policy. Additionally, before buying your policies, you should consider how they interact with your estate plan and be aware of any possible tax implications. Your financial life is an intricate puzzle, and it’s important to make sure every piece works together to cover your bases and get you to your goals.
What Next?
If you aren’t sure if your life insurance policy is right for you or you are ready to take the plunge into life insurance, it can be helpful to talk to a financial advisor and review your options. An advisor experienced with insurance policies can offer guidance on the products available to you and how they can integrate into your other financial strategies.
If you have questions about life insurance, want to discuss your options, or would like to schedule a review of your existing policies, reach out to us at info@montagewm.com or call (585) 419-2270 to get started.
Fixed insurance products and services offered through Montage Wealth Management.
