Life insurance is an important investment, and you don't want to buy an unsuitable policy or discover that you've purchased too much or too little. But if the fear of making a bad decision is stalling your effort, know that failing to buy life insurance at all can be one of the most costly mistakes you can make for your family.
"The data is clear," says Jack Dolan, a spokesman for the American Council of Life Insurers, a trade group. "Americans are underinsured, and they're not buying coverage in amounts that equal their needs."
An August 2010 report by LIMRA, an insurance research organization, revealed that ownership of individual life insurance has fallen to a 50-year low in the United States: 30% of households (35 million) have no coverage at all.
But ditching an inappropriate policy after paying premiums for several years is a terrible waste of money. We asked a variety of insurance experts to tell us the biggest mistakes people commonly make when shopping for life insurance.
Mistake: Undervaluing a spouse who has no income. In addition to underestimating the cost of replacing the income of a working spouse, life insurance buyers often neglect to place correct value on a non-earning spouse. Feldman says it takes about $117,000 a year to replace that person, and "most people don't understand the impact of what a stay-at-home spouse saves a family."
Mistake: Buying a life insurance policy with premiums that increase over time. Too often, life insurance buyers find that they can't afford the ever-escalating premiums and must let the policy lapse, says Amy Bach, the executive director of United Policyholders, a nonprofit dedicated to insurance education and consumer rights.
Mistake: Insufficiently reviewing all types of life insurance available. Dolan says that "term life insurance for young people in particular typically provides a greater bang for the buck than whole life insurance . . . however, the lifetime of level premiums that comes with whole life insurance is unappreciated by too many people who think in the short term. Whole life insurance, with its cash value, also promotes savings."
James Hunt of the Consumer Federation of America, a consumer advocacy group, cautions against cash-value policies in general because so many buyers ditch them in the early years of the policy. "This is not to say that cash-value polices can't be decent investments when held at least 20 years, preferably a lifetime," he says. But when people let their whole life insurance policies lapse, the "excess of premiums paid over term (life insurance) premiums . . . is lost."
A 2009 report from LIMRA on lapse rates shows that close to 12% of whole life policies lapse in the first year, 10% lapse in the second year and almost 7% lapse in the third year of ownership. By contrast, lapse rates for term life insurance were around 7% in years one and two and about 6% in year three.
Continued: Make sure you understand your policy
