There are many myths surrounding the world of life insurance that prevent people from looking at it as part of their overall financial solution. Investing in your family’s financial protection early on and talking with a licensed professional can help dispel these myths first hand, making the overall process a more confident one.
Life insurance could be a complicated financial vehicle. Given that, it’s not surprising that there’s a growing gap between the U.S. population and the number of life insurance policies purchased. According to data from LIMRA, a leading research, learning and development organization for life insurance, retirement, and financial services, the U.S. population has an increasing coverage gap for life insurance policies (see graph below). More than 150 million Americans have no life insurance coverage. Even the households who own life insurance may not have enough coverage to keep the families financially secure. As of 2016, LIMRA’s life insurance needs model estimates that 48% of U.S. households have an average life insurance coverage gap of $200,000, which is equivalent to more than $12 trillion in total market need. This is one of the biggest gaps in the history of the U.S. financial services, both in terms of people and dollar amount.
Why is there an increasing gap between our needs and the life insurance coverage? Understanding the benefits of a life insurance policy may help you better decide whether to purchase a policy and how much coverage you would need. To help you separate reality from fiction, below we will discuss 21 myths about life insurance policies.
Myth 1: Life Insurance Is Too Expensive
Many people assume that life insurance policies are very expensive. 80% of consumers overestimate the cost of life insurance, according to a 2015 study by LIMRA. In reality, there are many types of life insurance products with each type tailoring towards different personal needs and wealth levels. For example, if you are relatively young and are in good health, you can start off with an affordable term insurance policy.
The same LIMRA survey showed that 63% of the Americans who need more insurance but have no plan to purchase it within the next year is due to perceived high cost of an insurance policy. 20% of the survey participants thought that a 20-year term insurance policy with $250,000 of death benefit for a healthy 30 year-old would cost $1,000 a year, while in reality it costs around $200, which is $16 per month. And the premium is guaranteed and does not change for 20 years. This $16 per month provides you assurance that should the unimaginable occurs to you, your loved one will be financially protected.
The premiums for the life insurance policy are usually affected by factors such as gender, issue age, and underwriting class (determined by underwriting process through an assessment of your general health condition, prescription drug records, driving records, etc.). If you are unsure of the cost for a life insurance policy, get a free quote from company websites or insurance professionals to better understand how affordable the policy is.
How Expensive Is Life Insurance?
Modern misconceptions about the cost of life insurance are one of the main reasons why many of the younger population choose to do without it when in actuality, it can be cheaper than dinner and a movie… even when you are 30.
Myth 2: Life Insurance Can Only Be Used For Death Protection
Having a life insurance policy not only provides your loved ones with financial protection should death occurs to you, it also provides benefits for yourself throughout your lifetime. For example, life insurance can be used as a bridge to delayed social security. Delaying Social Security may be the most optimal way for married couples to decrease the odds of outliving their income. Individuals can start benefits at any time between age 62 and age 70. Delaying these benefits beyond age 62 results in a higher initial benefit and, therefore, higher lifetime income to a retiree who lives longer than average during retirement. Further, since a widow/widower will inherit a Social Security benefit from a spouse who passes away if it is higher than the amount she or he is currently receiving, delaying a benefit can increase a future survivor benefit. Life insurance cash values can be used to generate income while an individual delays his or her initial claim of Social Security benefits.
Myth 3: Ratings Of The Life Insurance Company Does Not Matter
The best way to understand your insurance company’s financial strength is through its financial ratings. When shopping for a life insurance, it is ideal to choose a company that has a top rating from at least one of the independent rating companies. A good rating means that the insurance company has the financial strength to ensure it will be able to pay off future death benefits to you should death occurs.
The most popular rating systems are A.M. Best and Moody’s. Each rating agency has its own methodologies to decide the financial strength for the insurance company. Keep in mind that there are differences between the rating agencies and they may give different ratings to the same insurance provider. Additionally, remember that since each rating agency focus on different criteria and factors, don’t automatically assume that the insurance provider with the highest rating is always the best choice.
How strong is your life insurance company? Read the report here.
Myth 4: Life Insurance Premiums Are Tax-Deductible
Unfortunately, your life insurance premiums are not tax-deductible if you have it for individual use. The exception is that if the policyholder is self-employed and the policy is purchased for asset protection purposes for the business owner. However, even though the premiums are not tax-deductible, your life insurance policy receives many favorable tax treatments especially compared to an investment vehicle. The death benefit your beneficiary receives is generally tax-free, policy cash value accumulated within the policy is tax-deferred and not taxable as current income, and policy distributions such as partial withdrawals, surrenders, policy loans, and policy dividends are not taxable up to the total premiums you have paid. These tax benefits for a life insurance policy can be leveraged in many ways, such as supplementing your income tax-free through any stage of your life, providing tax-free benefits if chronic or terminal illness occurs, and reducing the risks of paying high tax during your retirement.
Myth 5: Employer-Provided Life Insurance Coverage Is Enough
You may be provided with a group life insurance policy through your employer as part of the employee benefit or federal employee benefits. Usually, the coverage is 1 to 2 times your base salary, and you have the option to purchase additional coverage up to 4 to 6 times of your base salary. This base salary usually does not include any additional compensation such as bonuses, incentives, equities, or other income you may receive. For a young, single person with very limited needs, the coverage provided by your group life insurance policy may be enough. However, if you have families and dependents, your group life policy coverage may not be sufficient to provide financial protection for your dependents. There are numerous online insurance needs calculator you can use to understand how much insurance coverage you need, based on factors such as your salary, investment rates, personal needs, inflation rate, etc.
You may loss the group life insurance policy if you leave your job. You can take the policy only if it has a conversion privilege. However, typically you may actually be able to get cheaper premium rates on your own if you are in better health. This way you can lock in the premium rates for a term policy, or start building cash value for a permanent policy.
Myth 6: Life Insurance Cannot Provide Any Healthcare Benefits
There is an array of life insurance riders that can help with a variety of your life’s needs. For example, you can utilize life insurance death benefit or cash value for health care. Chronic illness or long term care riders can be used to provide money in the event of chronic illness to pay for related healthcare costs or any other needs. These riders allow the insured to accelerate the death benefit to pay for chronic illness expenses should they occur. Unlike a long term care insurance, the benefits are not “use it or lose it”, meaning that if no long term care is needed, long term care policyholders will not receive any benefits. Chronic illness riders attached to a life insurance policy provides healthcare benefits should chronic illness occur, or will be added on to your death benefit if you are healthy throughout your life. This is a “win-win” solution. Additionally, a life insurance policy’s cash value can be used to pay for out-of-pocket healthcare costs.
Myth 7: You Do Not Need Life Insurance If You Are A Stay-At-Home Parent
Life insurance needs is not only measured by your income; it should also include the intangible non-monetary benefits you provide such as childcare if you are a stay-at-home parent. You need a life insurance policy if you are a parent. If the unthinkable happens to you, who will take care of your children? What if you have elderly parents or other dependents that also need to be taken care of? Your surviving spouse will need additional financial help to hire babysitters, send kids to daycares, or parents to nursing homes or assisted living. Salary.com estimates the stay-at-home parent’s contributions to be an equivalent salary of $112,962 per year. When determining your life insurance needs, keep in mind that life insurance is to provide protection for your entire financial plan; so take into account of the non-monetary benefits you provide to your families.
Myth 8: You Have To Wait Through A Lengthy Underwriting Process
While for most of the life insurance especially permanent insurance policies, you will still have to go through an underwriting process that could take a couple of weeks to several months to get your underwriting class and the insurance policy started, the insurance landscape is changing. If you are looking for a term life insurance policy without the hassle of going through medical underwriting and waiting to hear about the final price, instant issue term can provide you with an insurance policy within minutes. All you need to do is to answer several questions in the application about your health, and you can finalize the policy with an agent. Even for traditional term life policies, the insurance industry is focusing on accelerating the underwriting process and providing as much convenience to consumers as possible. Many companies have implemented or started to develop accelerated underwriting process that uses mathematical modeling to quickly predict your underwriting class based on your personal data and various health records. If you are young and are in good health condition, you can expect to have an insurance policy started within 2 weeks.
Myth 9: Life Insurance Is A Waste Of Money If Nothing Happens To You
Term insurance is not an investment product and is designed to purely cover your mortality risk. Life other insurance such as home, auto, or health insurance, term life insurance will not pay out if there is no claim within the level period. This makes it the most affordable way to mitigate mortality risks and ensure that your family is financially protected should the worst happen to you. If you are concerned about not having your money back if nothing happens to you, for term insurance, you can purchase return-of-premium (ROP) term, meaning that your premiums paid are guaranteed back if no claim occurs. The ROP term policies are usually more expensive than a plain term, but your money is guaranteed back.
Myth 10: Young And Healthy People Do Not Need Life Insurance
Insurance is to financially protect your loved ones if death occurs to you. Life insurance is crucial for anyone with dependents and it has nothing to do with your age or health condition. When you are young and healthy, the most plausible cause of death is not aging or illness, it is death through an accident. Many of us may have acquaintances or friends who, sadly, have passed away due to accidents. If you have dependents, it is important to protect your family in case of an unexpected death. Additionally, having a life insurance policy when you are younger and healthier locks in the lower premiums since your mortality risk is lower when you are younger and healthier. And you can always convert your term life insurance to permanent life insurance without additional underwriting throughout the level term period if you are younger than a certain age such as 65-year-old.
Myth 11: PMI Is A Life Insurance
Many people may have heard of PMI when they are shopping for new homes and looking into mortgages, and you may think it’s a life insurance policy. Private Mortgage Insurance (PMI) is required when a home-buyer makes a down payment of less than 20% of the house value. PMI is insurance to prevent the lender against any loss if the home-buyer failed to pay off the mortgage. PMI is not a life insurance policy.
However, life insurance is an important way to ensure that your family is financially protected from not being able to pay off the mortgage balance if something happens to you. The coverage for the life insurance policy should be determined by the amount of mortgage, length of time, and the projected income. By having a life insurance policy to cover mortgage balance, your family would receive a lump sum to pay off the mortgage or more if death occurs to you.
Myth 12: Poor Health Disqualifies You For Life Insurance
If you are in a poor health condition or have a chronic illness, you should not automatically assume that you will be turned down for a life insurance policy. Your health is an important factor to determine your premium rate. However, even though you may have a poor health condition, you may still be qualified for insurance, but you may need to pay a more expensive premium. For example, guaranteed issue life insurance policy requires no medical underwriting. It provides coverage for anyone who applies to it, regardless of the health condition. This kind of policy is usually more expensive than other policies, and you could end up paying more premiums over time than the death benefit if you live longer than average. Timing of insurance application is also an important factor. You may be declined for a policy right after a chronic illness diagnosis, but you can always reapply after some effective treatments. Additionally, if you have an existing policy, you may be able to increase your coverage without additional underwriting. For example, you can convert part or all of your term life policy to a permanent policy; some policies may also offer options to increase coverage up to a certain amount without additional underwriting.
Myth 13: You Cannot Convert A Term Insurance Policy To A Permanent Policy
Term conversion is an option to convert some or all of your term life insurance policy to a permanent policy regardless of your health condition (without needing additional underwriting). Permanent life insurance includes guaranteed universal life (UL), whole life, indexed, and variable life insurance. Most term policy includes a build-in term conversion option. For example, if you purchased a term policy to ensure your children will be covered for college should anything happens to you, and now they are all grown and you would like to have a permanent life insurance policy so that your children and loved ones are covered throughout your whole lifetime. This could be a valuable option since no additional underwriting is required, thus it may provide cheaper premiums compared to purchasing a new permanent policy. It is important to speak with your agents and understand the term policy beforehand, as the conversion option is usually limited up to a certain age.
Myth 14: You Do Not Need Life Insurance If Your Children Are Grown Up
Life insurance can help you in various ways through different stages of your life. After your children are grown up, life insurance can be beneficial for retirement planning, debt payment, final cost and estate tax payment, etc. For example, life insurance is a powerful tool to supplement retirement income or mitigate any risks to derail your retirement income. For example, the benefit of a life insurance policy is that you can use it as cash reserve if equity investments under perform early in retirement. If investment returns are poor during your early years of retirement, you can take policy loans and withdrawals from the policy’s cash value to generate supplemental income so that withdrawals do not need to be made from the 401(k)/IRA portfolio that is invested in the capital markets. This will allow those assets to remain intact and fully benefit from positive investment returns when they occur.
Myth 15: You Are Better Off Investing The Money Than Purchasing Life Insurance
Life insurance has several advantages compared to an investment vehicle such as stock and mutual fund. First, life insurance receives preferable tax treatment compared to an investment vehicle. The death benefit from a life insurance policy is generally tax-free, and the cash value build-up within the policy is tax deferred. You can generally withdraw your cash value tax-free up to basis. This could be attractive for people who are in higher tax brackets and have maxed out all other tax-advantaged options such as 401k, IRA, and HSA. Second, you endure more risks from an investment vehicle. For a permanent life insurance policy, usually there is a guaranteed minimum return within the policy. So even if the market is declining, your cash value is still guaranteed not to drop or will increase by the guaranteed amount. Third, life insurance will round up your investment portfolio. Instead of having investment purely in the equity market, having a life insurance policy means you are exposed to your own mortality risk.
Myth 16: You Have To Purchase A Life Insurance Policy Through “Brick and Mortar” Agents
Life insurance policies are traditionally sold through “brick-and-mortar” insurance agents or financial professionals. With our current rapid advance in technology, more and more people are turning to Internet for information and commerce. Sometimes you may find it inconvenient to go to an actual insurance agency or may feel pressured into buying a policy with an agent on site. Instead of purchasing life insurance face-to-face from an agent, you can purchase an insurance policy online or through the phone from an online life insurance agency. An online insurance agent can assist you throughout the process of understanding life insurance products, to estimating life insurance needs, all the way till the start of your insurance policy. It provides the speed and convenience of the Internet as well as the insurance expertise you may need from a financial professional.
Myth 17: Term Life Insurance Is Better Than A Permanent Life Insurance
Although a term insurance policy may seem cheaper and simpler to understand compared to a permanent policy, a permanent policy has many advantages that are beneficial to understand for your financial planning. A permanent life insurance builds up cash value inside the policy by a guaranteed rate (whole life or guaranteed UL), or by an index growth (e.g. S&P 500), or grows with the equity market returns. You can tap into the cash value through withdrawal any time if you need to supplement your income, or you can take a loan against your policy tax-free up to basis, subject to an interest, which is usually far lower than the rates for your credit cards. Additionally, for whole life policies, it caters towards long-term goals by offering consistent premiums and cash value growth; for other permanent policies, they offer flexibility in premium payment. You can skip a payment, or pay for a lower amount when you need the income for other purposes. For people who are interested in death benefit and cash value element, permanent policies could be a better option.
Myth 18: Your Beneficiaries Need To Pay Tax On The Death Benefit They Receive
Your beneficiary receives the death benefit if you die when insured. IRS noted that death benefits from a life insurance contract are generally tax-free for the beneficiary, which means your beneficiary will not need to pay tax on the death benefit they receive. However, if the death benefit is received in installments instead of lump-sum payment, any interest gained portion of each installment payout is taxed as ordinary income, and the principal portion of the death benefit is tax-free. The tax-free benefit your beneficiaries receive will protect them financially and help pay for things such as funeral expenses, outstanding loans, and college tuition.
Myth 19: It’s Always A Better Deal To Purchase A Policy Directly From The Insurance Company
As we discussed previously, there are more and more opportunities to purchase a simple life insurance such as term policy from the insurance companies directly. However, you may not always get the best deal when you purchase a policy directly from insurance companies themselves. For example, there are term policies that are simplified-issue, meaning that you only need to fill out couple of questions and will be able to get an insurance directly. No additional underwriting is required. Although this may sound simple and convenient, if you are young and healthy, this may not be a good deal for you. When the insurance companies price this kind of policies, they need to include people from all health conditions and get an average price. By purchasing the simplified-issue policies online, you lose the granularities in insurance premiums that are meant to provide healthier people with cheaper rates. Additionally, an agent will be able to walk you through the details of the policy, help you figure out exactly how much insurance coverage you need, and provide you the best price based on your health condition. An online agency combines the best of two worlds. It provides both the convenience and non-intrusiveness of the Internet, and the expertise from a financial professional. You can research insurance policies at your own pace, get an instant quote without needing to provide your personal information, and be assisted by online insurance agents should you have any questions.
Myth 20: You Have To Purchase Two Policies To Cover Both You And Your Spouse
A survivorship life insurance policy insures the lives of two people who are usually married under a single policy. It pays out the death benefit when the second person dies. This is an effective way to cover the couple since survivorship policies are generally cheaper than two individual policies. A survivorship policy has many benefits. For example, it helps preserve your estate. Your beneficiary will be able to use the tax-free death benefit to offset estate tax, keeping your estate intact. Additionally, it may also be an efficient tool for business continuation. Especially for a smaller business, it provides the funds needed to continue with the business if death occurs to one of the key business partners.
Myth 21: Husbands Should Have Greater Amount Of Insurance Coverage
A survey showed that wives are significantly less likely to have life insurance policy than husbands; and for the wives who do have insurance, their coverage is significantly less than the husband’s. This may be mainly due to women’s contribution to the household is underestimated. There are many considerations when determining the life insurance coverage. Except for the financial income, factors such as childcare, house cleaning, elderly care would cost the family extra money should the person who’s doing these passes away. Additionally, some life insurance has accelerated death benefit riders attached to it to cover chronic illness. This kind of rider is very attractive for females since usually the wife will take care of the husband when he’s ill; he passes away and when the wife is sick, the benefit from the life insurance policy would be helpful to cover any chronic illness costs for her.