Making a mistake with your life insurance can hurt the loved ones you want to protect with the policy.
But with careful planning and know-how, you can steer clear of common pitfalls and make sure your family is properly covered.
Here are 10 moves to avoid.
1. Relying solely on group life insurance
Group life insurance is a nice employee benefit, but the amounts employers provide—typically one to two times annual salary—usually aren’t enough for people who need life insurance. And in many instances, the coverage ends when you leave the company, leaving your family without the financial safety net.
Almost one-third of Americans think they need more life insurance, and 43% say they would feel a financial hit within six months if their family’s primary wage-earner died, according to the 2015 Insurance Barometer Study by industry groups LIMRA and Life Happens. Yet 54% of Americans don’t plan to buy life insurance in the next 12 months.
If you need life insurance, it’s better to buy sooner rather than later. Life insurance rates increase as you age and develop health conditions, such as high blood pressure.
3. Buying a policy without shopping around
Life insurance rates for the same coverage vary widely by company. The price for a 20-year, $500,000 term life policy for a healthy 30-year-old nonsmoking man can range from $244 to $655 a year, according to NerdWallet research.
Besides comparing prices, it’s also important to check the financial strength rating of any company you consider. You want the strongest possible ratings to make sure your company will be able to pay out an eventual death claim. Ratings agencies such as A.M. Best provide financial strength ratings.
4. Choosing the wrong type of life insurance policy
Term life insurance, which covers you for a certain number of years, is sufficient for most people who need life insurance, and it’s cheap. A healthy 30-year-old nonsmoker can get $500,000 of term life coverage for 20 years for less than $5 a week.
Permanent life insurance, such as whole or universal life, covers you for your entire life and features an investment component called cash value. The cash value accumulates gradually. You can borrow from the cash value or surrender the policy for the money.
Because of the lifelong coverage and cash value, permanent life insurance costs many times more than term life. A $500,000 whole life policy can run around $5,000 a year for a man and $4,400 for a woman, based on rates NerdWallet found for 30-year-old nonsmokers.
Permanent life insurance is an important financial tool for some consumers, such as those with lifelong financial dependents and wealthy people who want to provide money for heirs to pay estate taxes. The policies are complex, so you’ll want help from a trusted financial advisor, such as one in NerdWallet’s network.
5. Buying the wrong amount of coverage
To get to the right number for how much life insurance you need, add up your long-term financial obligations then subtract your current life insurance coverage, if you have any, and liquid assets such as savings. Obligations may include college tuition and other child-related expenses, the mortgage and other debts and your annual income multiplied by the number of years you’d want it replaced.
6. Naming a minor as a beneficiary
You might buy the policy for your children’s benefit, but naming them as beneficiaries on the policy when they’re still minors is a bad idea. If you die before they’ve reached legal adulthood, the life insurance company can’t pay benefits until the court appoints a guardian. That takes time and money for attorney fees and court costs.
Instead, name your spouse or other trusted adult as the beneficiary. Or set up a life insurance trust for your children, and name the trust and trustee as the beneficiary on your life insurance policy. You can stipulate how the money should be used.
7. Naming your estate as the beneficiary
Generally it’s better to name a trust, an organization or the people you want to receive the proceeds as beneficiaries. If you name your estate, your estate’s beneficiaries won’t receive the benefits until the legal probate process is finished, which can take months or even years if the estate is complicated. The life insurance money could also be subject to claims from creditors if you name your estate as the beneficiary.
Normally, life insurance benefits are shielded from creditors when you designate a beneficiary other than your estate.
8. Owning the policy on your life insurance if you have a big estate
Being the policy owner on your own life insurance is something to avoid if you have an estate large enough to be subject to federal estate taxes. In 2015, that’s an estate worth more than $5.43 million for a single person or $10.86 million for a married couple.
If your estate is worth more than this exemption amount, the life insurance proceeds could be included as part of the taxable estate. To get around the problem, you can have a trust purchase the policy, or you can give the money for premiums to an adult beneficiary to own and pay for the policy. You can give up to $14,000 per year to any individual free of federal taxes.
9. Keeping your life insurance policy a secret
Some people don’t like to talk about their personal finances, even with close family members. But somebody needs to know about the life insurance policy, so the beneficiary can make a claim. Besides a spouse or adult children, here are people with a good reason to know about your policy: a financial advisor, an estate planning attorney and anyone you appoint in your will as the personal representative or executor of your estate.
10. Forgetting to update beneficiary designations
Financial advisors recommend that you review your policies every few years to make sure they provide enough protection, and that you update beneficiaries if necessary. Make sure you review coverage after major life events, such as marriage, divorce, remarriage and having a baby.
The bottom line
By avoiding these all-too-common pitfalls, you can make sure your life insurance does what it’s supposed to do — provide the protection your family needs.
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