Buying life insurance is not something you do every day. Once you sign the contract, you cannot change its terms. Of course, you can cancel the policy any time and take out a new one, but that will cost you.
To ensure you buy the right policy the first time, it is important to know what not to do.
Here are the five most common life insurance mistakes to avoid:
Buying the wrong amount of coverage
Buying too much coverage is just as bad as buying too little. Too little coverage means your loved ones will not receive adequate financial assistance and may struggle to live comfortably after you are gone. Too much coverage means paying for something that your family will not need. You can instead spend this money on other things, like that dream family vacation you have been postponing for the last three years. Life insurance expenses should not hold you back from living your life.
Speaking of coverage amount, how much is enough?
Life insurance needs are not one-size-fits-all, but there are some guidelines that help you get a rough estimate. One guideline is to buy 10 times your annual net salary. Another is to multiply your yearly take-home income with the number of years you expect your family would need financial support.
Yet another is the DIME formula. It includes all four key areas — debt, income, mortgage, and education — you should consider when determining your life insurance needs.
- Debt and final expense: Calculate your total debt, apart from mortgage, and expected end-of-life expenses.
- Income: Determine the number of years for which your loved ones would need financial support and multiply your net annual income with that number.
- Mortgage: Find out your mortgage balance.
- Education: Calculate the cost your children’s education.
Once you have calculated each of these obligations, add them up to get a fair estimate of how much life insurance you need.
Buying the wrong type of life insurance policy
Life insurance policies are either permanent or term. Permanent life insurance offers coverage for as long as you live and includes a savings component. Part of each premium payment goes into the built-in savings account and this money — referred to as the policy’s cash value — grows at a fixed rate set by the insurer. Since this is basically your money, you can tap into your cash value anytime during your lifetime.
Despite its unique features — lifelong coverage and cash value — permanent life insurance is not right for everyone. Not only is it 10 to 15 times more expensive than term life, but compared to traditional investment vehicles, its rate of return is lower and administrative fees higher.
If you want to take out a permanent life insurance policy for its savings feature, buy it only if you have already maxed out traditional investment vehicles. Its permanent life insurance coverage, on the other hand, can prove beneficial for those with a lifelong dependant.
For most people, term life insurance is sufficient. It is affordable, easy-to-understand, and provides coverage for only as long you need.
If you want life insurance to secure your family’s future until your children become financially independent and/or to cover your debts, term life insurance is the right choice. Keep in mind if you are buying a term life plan to help your loved ones pay off lingering debts upon your death, its term should be at least as long as the term of your biggest debt, which for most people is the mortgage.
Lying on your life insurance application
An underlying health condition or a habit like smoking can push up your premium rate. When you are filling out a life insurance application, it may be tempting to lie or withhold information to secure a better rate. But this can do you more harm than good.
There is a good chance the insurance carrier will find out the truth anyway during a paramedical examination or by accessing your medical records. If you get caught lying while you are still in the application process, the insurer will likely turn down your application or charge a higher rate — but that is not the worst of it.
All life insurance policies include a contestability clause. This clause allows insurers to contest and deny a claim if the insured dies within two of years of taking the policy. That means your loved ones may not receive the death benefit that you are paying for. It would be a shame to spend money on a policy that your family cannot claim.
Honesty is the best policy when it comes to life insurance.
Thinking you cannot qualify for life insurance because you have been rejected once
Life insurance carriers see us as risks with legs. They evaluate the risk of insuring each applicant through a process called underwriting. Each applicant is assigned a health rating based on their health, age, medical history, and some other factors. The better the health rating, the lower the insurance premium.
If you have a serious health issue, the insurer may even deny your life insurance application. But just because one provider refuses to extend you coverage does not mean others will reject you too. Each insurer has its own eligibility criteria, and some providers specialize in writing policies to high-risk applications.
If you have been turned down once because of poor health or a dangerous occupation, speak to an independent insurance broker. They can help you submit an application with providers that are more likely to extend you coverage. Also, if you just cannot get a medically underwritten life insurance policy, you always have the option of taking out a simplified issue or guaranteed issue plan.
These life insurance policies involve little or no medical underwriting, so you can qualify even with a serious health issue. While these plans offer limited coverage, some coverage is better than none. It make take longer to get a life insurance policy if you are a high risk individual but, it is certainly not impossible.
Not shopping around for the best rates
Life insurance premiums vary significantly among insurers, and not shopping around can cost you several hundreds of dollars in the long run. Insurance carriers treat each applicant differently, so while one provider might offer you an expensive rate, another may still offer you a low monthly rate.
For instance, if you have type 2 diabetes, you could receive a decent premium rate from one insurer and a higher rate from another.
Sometimes, life insurance can feel complex and intimidating — and that is okay. The best way to ensure you buy the exact coverage you need is by working with an experienced broker.
A Dundas Life expert can walk you through all the available options and help you choose a life insurance policy that both meets your needs and fits your budget.