Term Life Insurance Pitfalls
Term life insurance is one of the most popular and cost-effective types of life insurance, in that it offers the highest amount of death benefit per dollar of premiums. Even though term life insurance is often thought to be simple and straightforward, there are several key mistakes and pitfalls that people can encounter when buying term life insurance.
Major term life insurance pitfalls include:
- Waiting too long to buy coverage – It’s crucial to buy term life insurance while you’re young and healthy.
- Buying the wrong amount of coverage – Many people find themselves underinsured because they forgot to account for certain key expenses.
- Buying the wrong term length – People often underestimate the length of time that they will need life insurance.
- Only insuring the primary breadwinner – Even if one spouse does not earn income, they still need to be insured.
- Not applying (assuming that the company would deny the application) – Even if people smoke or have health conditions, it is still possible to qualify for life insurance coverage. It never hurts to apply.
- Buying based only on premium price – The cheapest policy is rarely the best.
- Not considering a convertible policy – Some of the best term life policies include an option to convert to a permanent life insurance policy.
Waiting Too Long to Buy Coverage
Most people buy term life insurance when they’re young and in good health – this enables them to qualify for low premium rates, since the insurance company views them as a good risk. After all, young, healthy people are unlikely to die.
But sometimes people delay. And delay can be costly. Whether it’s due to starting a family later in life, or just the natural procrastination that tends to keep people from confronting big financial issues and major life decisions, too many people wait until their 30s and 40s to apply for term life insurance – and by that time, they might have to pay higher premiums, might not qualify for as long of a term as they wanted – or they might get denied coverage altogether. Buying term life insurance while young and in good health can save thousands of dollars on premiums over the course of a policyholder’s life.
Buying the Wrong Amount of Coverage
Most people don’t have as much life insurance coverage as they need. The goal of term life insurance is to provide financial protection for the policyholder’s loved ones by replacing the policyholder’s income in case the policyholder dies. Even though term life insurance is sold in big amounts - $250,000 to $500,000 and more – most people underestimate the amount of life insurance they need.
Financial advisers often recommend that people have enough life insurance so that the beneficiaries would be able to live off the interest accrued by the death benefit – for example, if a policyholder’s family needs $50,000 a year to live on, that policyholder should have $1 million of life insurance coverage (assuming 5% interest).
Buying the Wrong Term Length
Term life insurance only covers the policyholder for a fixed term of years – with choices ranging from 5, 10, 20 or 30 years. Policyholders need to choose their term carefully – get too short of a term, and the policyholder might develop a health condition that prevents him from getting further life insurance coverage. Get too long of a term, and the policyholder might pay unnecessarily high premiums just to insure his life past the point of highest vulnerability.
The important thing to consider with term life insurance is how long will the policyholder’s dependents be relying on the policyholder for financial support? Insuring the sole breadwinner of a family with three children under age 5 is a far different situation than insuring two working parents of 17-year-olds who are almost out of the house.
Another thought to keep in mind is that people’s incomes and responsibilities tend to grow over the course of their lives. It might take a lot more insurance to replace the income of a successful 45 year old executive than it took to insure a 25 year old just out of college. Be prepared to adjust accordingly.
Only Insuring the Primary Breadwinner
Term life insurance is primarily intended to replace the policyholder’s income in the event of a death, but all parents in a family need to have life insurance, whether or not they earn income.
Even if there is a “stay-at-home spouse” who cares for the children and maintains the household and has no income, that person’s work would cost money to replace. In the event of a stay-at-home spouse’s death, the family would have to hire child care providers, housekeepers, maintenance workers, and others to help replace the labor that used to be done by the stay-at-home spouse.
Life insurance is not only about replacing income, it’s about securing the family’s lifestyle and material comforts.
Not Applying (Assuming a Denial for Health Reasons)
Some people who smoke or who have existing health conditions might be reluctant to apply for life insurance. Don’t be. It never hurts to apply. Smokers are not excluded from getting life insurance, although they do have to pay higher premiums. There are many types of life insurance and there are often affordable solutions available for almost anyone’s health circumstances.
Buying Based Only on Premium Price
In the world of term life insurance, low price is not always a sign of good value – in fact, the opposite is often the case. Some of the best and financially strongest life insurance companies tend to charge slightly more for their premiums – this is the cost differential that pays for more precise underwriting, better customer service, a more responsive network of insurance agents, and all the other infrastructure costs of selling insurance.
In addition, some of the higher-priced term life insurance policies also have added features that make it worth the cost – for example, term life insurance policies that can convert to permanent coverage often cost more than non-convertible policies. Don’t pay attention just to the price; pay attention to the value that you get for the price.
Not Considering a Convertible Policy
Most people buy term life insurance when they’re young and healthy – but what happens when a health problem arises? In order to maintain insurability and continue receiving life insurance protection, policyholders should consider getting a term life insurance policy that can be converted to a permanent policy.
For example, consider a young woman who buys a term life insurance policy at age 30 with a 10 year term. When she’s 38 years old (two years shy of the end of the term), she discovers that she has a hereditary disease that might make it impossible to qualify for any other life insurance plan.
Fortunately, because she has a conversion option, she can switch her term life policy to a permanent policy – enabling her to continue protecting her family even though she might not be able to get insurance on the open market.
While term life insurance is a cost-effective solution for many people, there are several key pitfalls to avoid. Before buying term life insurance, make sure to consider how to decide the right term length, how to buy enough coverage to thoroughly replace the policyholder’s income, how to insure all parents instead of just the primary breadwinner, and keep in mind the value of higher premiums and the options to convert to a permanent policy.
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