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Lessons from a life insurance policyholder

Buying life insurance can be a daunting process, with many options and complexities – and often, people don’t know what they need from a life insurance policy until they buy a policy thatisn'tquite the right fit.

Doug Smith, a 37-year-old computer programming manager from Connecticut, has had several life insurance policies during the past 15 years, and he recently made some changes to better align his life insurance with his family’s needs.

Smith’s story is a great example of how sometimes when you first buy life insurance, there are things that you wish you'd already known.

life insurance lessonsGet in early

Smith always has been risk-conscious and interested in financial planning. So he bought life insurance right out of college, before he was even married or had kids.

Life insurance expert Tony Steuer says that while it might not hurt to buy life insurance before you start your family, it’s not necessary for most people.

“In general, it only makes sense to get life insurance when you have a need for life insurance – for example, once you get married or start a family, and have people who are depending on your income,” Steuer says. “Just like you don’t need to buy auto insurance before you buy a car, most people don’t need to buy life insurance until they have a specific need to protect people from the loss of their income.”

During the early part of his career, Smith bought a few whole life insurance policies with coverage amounts totaling $750,000. The goal was to use these policies as long-term investments, as well as for insurance coverage. Unlike term life insurance, which provides only a death benefit during a set period of time, whole life insurance builds cash value as the policyholder pays the premiums over time.

While Smithdoesn'tregret buying the whole life insurance policies, their investment performance didn’t work out as well as he'd hoped.

“My investments suffered along with the performance of the overall stock market, losing around 15 percent of their value,” Smith says. “Although my other retirement investments performed even worse, I realized that my whole life insurance policiesweren'tgoing to reach the original growth estimates, and I wasn’t paying close enough attention to what the investments were doing, so I had to rethink my approach to insurance.”

Fortunately, Smith was able to wring some financial benefits from his whole life policies. He was able to borrow against the cash value to help make a down payment on his first house.

Adapting to changes

Fast-forward a few years: Smith had gotten married, and he and his wife, Heather, had a child, a boy named Jameson who is now 1 year old. Doug evaluated whether his life insurance was adequate for his growing family. After a discussion with his life insurance agent, Smith realized he was underinsured.

“I had put a lot of money into the whole life insurance policies, but I came to realize that I needed to switch a few of them to term life just to get more in line with where I needed to be for insurance rather than as an investment goal,” Smith says.

So in 2010, Smith decided to switch some of his whole life insurance policies to a 20-year term life insurance policy. He now has a total of four life insurance policies: a level 20-year term life policy for $1 million of coverage at $70 a month, and three whole life policies totaling $300,000 worth of coverage for $285 a month. Total amount of life insurance coverage: $1.3 million.

Smith says he wishes that when he first bought life insurance, he would have focused on covering his life insurance needs instead of simultaneously thinking about investments.

“I should have thought harder about what my actual goals were in having a life insurance policy,” Smith says. “Especially after having a child, it became more important for me to have a higher level of life insurance coverage.”

Steuer agrees that people generally need to align their life insurance coverage with their needs for income protection -- not with their investment goals.

“Usually, it doesn't make sense to combine life insurance and investments,” Steuer says. “The first consideration is the need for life insurance, usually for a finite period of time until either the family’s amount of investments and other assets are greater than the life insurance amount or the coverage is no longer needed."

Steuer adds: "For example, if your goals for life insurance are providing coverage for children and you have a 2-year-old, you might want to buy insurance for 20 years to get that child through college. If your goal is to provide for a spouse, you should try to buy a long enough term life policy to cover that surviving spouse until they reach retirement age. If providing for your spouse is the goal, you need to make sure your life insurance term is long enough to last until the surviving spouse has enough money saved in an IRA or other retirement plan to match the amount of life insurance coverage.”

Steuer says cost is another consideration in weighing term life insurance against whole life insurance.

“Costs and expenses for a cash value life insurance policy, whether it’s whole life, universal life, variable life or other options, tend to be significantly higher than a term life policy,” Steuer says. “People are often better off obtaining a term life insurance policy and investing the difference in premium amounts in a low-cost mutual fund.”

Better insurance, lower cost

When Smith switched his life insurance policies from whole life to term life, he was surprised to find that he could nearly double his coverage amount (from $750,000 to $1.3 million) while reducing his monthly premiums by $100.

“Even though my coverage doubled, I’m actually spending less than I used to pay for premiums each month,” Smith says. “After having owned whole life insurance policies, I was surprised at how inexpensive term life insurance could be. ”

Is $1.3 million “enough”?

Smith says $1.3 million sounds like a lot of money "until you think about college for the kids, paying for the mortgage and all of those things you need to do in life. For me, that’s really not even 10 years of earning potential.”

When deciding how much life insurance to buy, Doug and his wife looked at their financial goals and life plans. They already have one child and plan to eventually have two more. They wanted to buy enough coverage to help pay off the house, offer some financial security for Smith’s wife and provide college money for the kids.

“I wanted to be able to leave my wife in a stable place and help take care of the education of our kids,” Smith says. “My attitude on life insurance is that itdoesn'thave to be a windfall, but it should be a safety net.”

Steuer says you can calculate how much life insurance is enough for your family in a few ways.

“One rule of thumb is that your amount of life insurance coverage should equal seven to 10 times your annual income,” Steuer says. “So for someone with an annual income of $130,000, a coverage amount of $1.3 million would be ‘enough’ by that measure.

"However, I prefer to advise people to look at how much income your family would need if you were to die. For example, if your family could live on $50,000 per year, and if they could invest the life insurance benefit to get a return of 5 percent per year – which is not likely in the current investment climate – then the amount of insurance needed would be $1 million.”

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