How to Buy Life Insurance

Buying the best life insurance, be it term life insurance, or permenant life insurance can be a complicated and even overwhelming project. While many life insurance companies offer online term life insurance quotes. If that is all you do, you may not end up with the best life insurance policy. A better approach is outlined below:

1.  Determine Your Life Insurance Needs

2.  Choose the Right Type of Life Insurance

3.  Talk to a Financial Advisor

4a.  Research Term Insurance

4b.  Research Permanent Insurance

5.  Buy a Life Insurance Policy

Step 1. - Determine Your Life Insurance Needs

The purpose of life insurance is to take care of dependents upon your death. There are three basic ways to figure out how much you need.

1. Income Replacement Approach - Add up your expected income until the day you retire.

2. Expense Approach - Add up expected expenses for your dependents:
  • estate taxes
  • funeral costs
  • outstanding debt
  • mortgage payments
  • medical expenses
  • education expenses
  • food, clothing utilities
  • property taxes, insurance
  • child care
  • nursing care
  • retirement savings
  • travel expenses

3. "Rules of Thumb" - These calculations, while easier to compute, are less likely to give an accurate result.

a. Some sources advise a multiple of 5 to 10 times your annual income. Younger people might use a higher multiple. Older people with self-sufficient dependents would use a lower amount.

b. The Rule of 200. Multiple the monthly needs of your dependents by 200. Then subtract off available assets. (This assumes the needs of your dependents don’t change)

Step 2. - Choose the Right Type of Life Insurance

There are basically two types of life insurance:
1. Term Life Insurance
2. Permanent Life Insurance (or Cash Value)

Permanent Life Insurance can be broken into 3 categories
a. Whole Life Insurance
b. Universal Life Insurance
c. Variable Life Insurance

1.  Term Life Insurance
  Term life policies cover you only for a specific period of time - usually for 5, 10, 15, 20 or 30 years - or until a specified age, such as 65. Most term life policies provide a one-time payment (benefit) to the beneficiary for the amount of the policy if the insured party dies during the coverage period.

  Key Attributes
  Premium Type - some policies charge more as the insured person gets older (increasing premium), while others maintain the same price for the term of the policy (level premium)
Renewable - A renewable policy allows the policyholder to continue the insurance for additional terms regardless of your health and without having to pass a medical exam. For example, annually renewable term provides fixed premiums and benefits for one year. At the end of the year, the policyholder may renew the insurance, but the premium will probably increase.
Convertible - Most term insurance policies allow an exchange of the policy for a cash value policy without a medical exam or answering health-related questions.

2.  Permanent Life Insurance (or Cash Value Life Insurance)
  a. Whole Life Insurance (or Ordinary Life Insurance)
  Whole life is a type of permanent life insurance, i.e. the policy and the premium payments are for the insured entire life. The premium is set at the beginning of the policy. The premium may be level or increase after a fixed time period, but the premium will not change from the amount shown in the policy schedule. Whole life (and other permanent life insurance policies) accumulate a cash value. The cash value is paid out upon the insured person"s death, but can also be used as collateral for loans prior to death.

  b. Universal Life Insurance
  Universal life differs from whole life in its flexibility. Within limits, you can choose the amount and timing of premium payments and the death benefits. The policy stays in force as long as its value is enough to pay its expenses.

  c. Variable Life Insurance
  A variable life policy allows the owner to invest the cash values in a selection of separate accounts similar to mutual funds. Separate accounts may include money market funds and mutual funds invested in stocks and bonds. A variable life policy is a higher risk to the owner than whole life or universal life because the cash value varies based on the investment performance of the selected accounts.

Policy Comparison
  Term Life  Whole Life  Universal Life  Variable Life 
Premiums  Lower  Higher on a set schedule  Flexible  Higher on a set schedule 
Duration  Specified period  Life  Flexible  Life 
Benefits  Death only  Death, cash value and loan  Flexible death, cash value and loan  Variable death, cash value and loan based on fund performance

So which type of policy is best for you?

Term insurance may be ideal if you:
  1. Have access to other types of tax-deferred retirement savings plans such as 401Ks
  2. Are comfortable managing your own investments
  3. Are looking for the most competitive rates

Cash value life insurance may be ideal if you:
  1. Have a hard time sticking to an investment plan
  2. Have a multi-million dollar estate. A financial planner and an estate lawyer may advise you to set up life insurance trust to save in estate taxes
  3. Don"t have access to tax-deferred retirement saving plans such as 401Ks
  4. Own a family businesses that is relatively illiquid. A cash value life insurance policy may be a good strategy to pay estate taxes.

Step 3. - Talk to a Financial Advisor
Try to talk to an independent financial advisor, ideally one who doesn"t sell insurance.

If you don't have a lot of money to invest, it may be difficult to get a financial advisor to spend time with you. It may take a little bit of searching, getting rejected, hounding and playing the sympathy card to get the time of a good financial advisor. But if you are successful, their help can be invaluable.

Step 4a. - Research Term Insurance
Choosing term life insurance is not as confounding as other types of life insurace.

1. Find an channel / agent. Term life insurance is sold directly over the internet, it is a competitive market, and prices have fallen significanlty in the past several years. To find an agent, I would start with word-of-mouth, by talking to friends, family and co-workers. Do they like their agent? Look in the phone directory (or on the internet) for local insurance agencies. Go and meet the agent.

2. Research the companies offering term life insurance in your state. Choosing the right company may really matter. Compare their credit ratings, past returns on policies and the number of complaints. Most of this information is available on the state insurance websites.

Step 4b. - Research Permanent Insurance
Choosing permanent life insurance is not only a complicated decision, but it will likely be one of the largest purchases of your life. For example, a $200K whole life policy for a 40-year-old male might have a premium of $4,000/year. If he lives to be 80 years old, he will have paid in $160K. This is an important decision that likely merits a bit of research and planning.

1. Educate yourself on the types of permanent insurance and the terms. Buy a book. Do some internet-based research.
- understand insurance terms
- understand the types of agents

2. Research the companies offering permanent life insurance in your state. Choosing the right company makes all the different. Compare their credit ratings, past returns on policies and the number of complaints. Most of this information is available on the state insurance websites. Companies with mutual or exchange in their names are likely mutual insurance companies (owned by their policy holders) and will typically pay higher returns (i.e. have lower premiums for the same amount of benefits)

3. Find an agent. Permanent life insurance is typically not sold directly over the internet, an agent is involved. To find an agent, call the insurance companies you identified in Step 2, they can refer you to an agent in your area. Talk to friends, family and co-workers. Do they have an agent they like? Are they happy with their policies? Be sure to verify that your agent is registered with the state before meeting with them (state insurance websites)

4. Talk to a few agents. Evaluate agents on how well they answer your questions, how personable they are, how long they have been in the business and how trustworthy you feel they are.

5. Choose the right policy by comparing company credit ratings, premiums and your evaluation of the agents.

Step 5. - Buy a Life Insurance Policy
Now that you've done all of the leg work, the final step should be realitively easy. Buy your life insurance through your agent or using your online provider. In either case, you will likely be asked to take a physical exam.

Congratulations -- you made it through. Now when are you going to fix the leak in the roof?