7 life insurance mistakes to avoid

By U.S. News & World Report

For most people, talking about life insurance sounds almost as fun as eating rotten fish. And while ignoring it can compound a family tragedy by turning it into a financial nightmare, more and more people are doing just that. A recent survey by the nonprofit Life Foundation indicated that one-fourth of Americans would consider canceling their life insurance policies in order to save money during the recession.

Before making that kind of drastic decision, consider these seven common insurance mistakes -- and you might decide to buy more coverage, not less.

1. Thinking you have enough. In a recent survey of middle-income Americans, Allstate found that while respondents generally agreed that everyone should have some level of life insurance, most believed that it should primarily cover bills and funeral expenses. Only 20% said life insurance should replace the income of the person who died, in order to continue to support any children and other dependent family members. The idea of having a policy that paid out seven to 10 times one's salary -- an amount that could easily make sense for someone with young children -- sounded like an attempt to sell a needlessly large policy to the respondents.

• MSN Money insurance planner

In fact, a third of adults have no life insurance at all, says Steven Weisbart, the chief economist for the Insurance Information Institute. Of the remaining people, many of them have only the insurance that comes from their workplace policies, which is usually not enough for people who want to support dependents after their death.

2. Not talking about it at all. "It's a topic that nobody really wants to think about," says Matt Easley, a vice president for Allstate Financial, partly because thinking about death is so uncomfortable.

Though life insurance isn't required the way auto insurance is, Weisbart says it is "morally required," because "if you have dependents, you owe it to them to protect them from the loss of your capacity to earn an income." (See "What if you got hit by a bus?")

3. Relying on old rules of thumb. Traditionally, people relied on a standard "seven times income" rule to calculate how much insurance they needed. But that's not a useful measure, Easley says, because people's situations are so different. A single person with no dependents will probably need much less insurance than someone with five young children, for example. Instead, Easley recommends sitting down and thinking about "the things you want to protect." How much would it cost to support your children in the way you want? To pay for their college or pay off the mortgage?

Calculate economic loss

Michael Bonevento, a senior financial adviser at Ameriprise Financial, also recommends making a "human life value" calculation, which looks at the economic loss that would come from a breadwinner passing away. For example, if he earns $100,000 per year and has 20 years left until retirement, then the value is $2 million. (Taxes then get subtracted out along with the amount the breadwinner consumes himself, and other benefits such as health insurance are added. Finally, the present value of that number is calculated.)

• Calculator: How much life insurance do you need?

The human life value is usually a higher number than what people come up with after considering what they'd like to be able to pay for if they were to die. Bonevento recommends purchasing insurance for somewhere between those two amounts.

Continued: Ignoring your non-monetary income

 1 | 2 | next >