Tiffany Hamilton knew as a college student that she would one day be an entrepreneur. With that in mind, she made sure to enlist the help of a financial planning company when she bought her first life insurance plan at 21, as she was just getting her start in real estate.
That first policy was a $20,000 term-life plan that cost her about $80 a month. When her salary increased, she decided she needed more coverage than that. As a single woman with a burgeoning business, she wanted to make sure she had enough coverage to take care of any debts and leave something for her mother..
Her insurance representative at the time encouraged her to up her coverage. So at 25, she converted her policy to a $1 million whole life policy.
“I thought by going to a financial planner, sitting down and answering the questions, and then going off of their recommendations, I thought I was doing the right thing,” Hamilton told MagnifyMoney. “Yes, the $1 million would give my mom X, Y and Z, but was that in my best interests?”
Now 35 and running her own real estate business based in Tallahassee, Fla., Hamilton has lately been wondering: Is it possible to be overinsured?
How much insurance is too much insurance?
As we grow in our careers, home life and families, paying for life insurance becomes another one of those obligatory items on our financial to-do lists, like establishing a 401(k) or an emergency fund. But the sheer volume of life insurance options available may have created a unique problem: Some of us might be overly insured. That is, our insurance coverage may be wildly disproportionate to our salaries and overall net worth.
Joel Ohman, a Tampa, Fla.-based certified financial planner and founder of Insuranceproviders.com, said it’s also easy to end up with a policy that has more bells and whistles than you genuinely need.
Generally speaking, life insurance is a type of coverage that provides a payout to a selected beneficiary in the event of the policyholder’s death. This is often called the “death benefit.” Many people aim for a death benefit that includes a payout substantial enough to cover a few years of the deceased’s salary, funeral expenses and any outstanding debts.
Those with families may also want to include money to pay off a house, children’s college funds and more.
Of course, there are other options for anyone who has a large estate, want to make charitable contributions, needs special tax breaks or has other complicated financial circumstances to consider.
“Unless there are complex estate planning requirements or the insured has exhausted all other investment options, then typically the idea to use life insurance outside of a straightforward death benefit payout is a fool’s errand that will only result in a fancier car for your insurance agent,” Ohman said.
The cost of being overinsured
The difference in premiums between insurance plans can be striking, and if you’re not sure precisely what to get, it’s easy to throw up your hands in frustration. But if you simply choose a plan that may “sound right” without carefully exploring all your options, you could easily wind up paying for more coverage than you need.
Most insurance websites include insurance calculators to make it easy to figure out what your costs could be for a variety of different plans. Using State Farm’s calculator for example, a $500,000, 20-year term policy for a 30-year-old woman in Arizona is about $33 a month. Comparatively, a whole-life policy is $460 a month. That’s a difference of nearly $5,000 a year.
In Hamilton’s case, she realized she was paying thousands of dollars more for insurance than she needed to. In 2016, she converted her $1 million whole-life policy into a $500,000 universal-life policy.
“That cut my budget down by almost $10,000 a year,” she said.
John Barnes, a certified financial planner and owner of My Family Life Insurance, said those cost savings can be important for families.
“My take is, you can be doing something else with that money,” he said. “Families today are squeezed. I’m not about to overextend them, I’m going to get them the right amount.” The additional savings, he said, could go toward retirement, college tuition or other financial need.
Ohman said that a simple term-life policy is a great way to get inexpensive insurance that will still take care of most families’ needs.
“When people are looking for pure life insurance, they want to protect their loved ones if something should happen to them, and they want them to be financially taken care of in a worst-case scenario,” he said. “Ninety-nine percent of the time, then, that cheaper term life insurance product is going to be the best fit.”
Chris Acker, a chartered life underwriter, chartered financial consultant and independent life insurance broker in Palo Alto, Calif., said he almost always recommends term-life insurance to his clients, particularly young families.
“If you’re talking about people in their 30s,” Acker said, term insurance “is hands down the best way to go.”
That’s because it’s an inexpensive way to get insurance that provides coverage for your entire family. Plus, you can always get additional insurance later. But he cautions against applying one piece of advice across all situations.
“The bottom line is, there’s no right answer,” he said. “No two cases are the same.”
Types of life insurance
There are two main types of life insurance: Term insurance and permanent insurance. When consumers typically think about life insurance, they are looking for an option that will provide their families with financial stability if the unthinkable happens. If you work full time for a company, it’s possible that your workplace has a some type of life insurance policy, often equal to one year of the employee’s salary.
But some experts recommend that families purchase their own insurance plan outside of their employer because employer-sponsored life insurance typically falls short of their family’s actual needs.
Permanent insurance does exactly what the name implies: It provides lifelong coverage. In addition to the death benefit also provided by term-life insurance, permanent insurance also accumulates cash value. But with that added benefit comes pricier premiums.
Variable universal life
Whole life is the most common type of permanent insurance. With a whole life policy, the premium never changes. Part of the premiums goes into a savings component of the policy, which builds cash value and can be withdrawn or borrowed. That cash value also has a guaranteed rate of return.
Variable life offers the same death benefit, but allows consumers the option to seek a better return by allocating premiums to investments like stocks and bonds.
Universal life lets you vary your premium payments and gives a minimum death benefit as long as the premiums are sufficient to sustain it.
Variable universal life insurance is a sort of mix between variable and universal life, meaning consumers can vary premium payments and can also allocate them among investment subaccounts.
Best for: Those who want a policy that offers cash value and stable premiums. There are also tax advantages to this type of policy.
Best for: Those who want the same advantages as a whole-life policy, plus the option of allocating premiums toward different stocks and bonds.
Best for: Those who want the same advantages of any permanent policy with the option of varying premium payments. For example, those who may want to start with a lower premium that increases as their finances do
Best for: Those who want the option to vary premium payments, but also the option to allocate those payments toward different stocks and bonds.
Term-life insurance provides coverage for a specified amount of time — let’s say 15 or 20 years. Customers pay a premium each month and are covered through the specified term. This is typically the cheapest insurance option.
Best for: Those whose need for coverage will disappear or change at some point, like when a debt is paid or children reach adulthood and go to college. Also good for those looking for a low-cost option.
Even within term- and whole-life insurance, there are additional products you could be offered, like mortgage life, return of premium (in which your premium is returned if you outlive your initial term) and final expense (which covers just funeral expenses). There’s even an option that would provide lifetime protection for your estate upon your death. With all the available options, it’s easy for the costs to add up.
Tips to choose the right life insurance
Use a life insurance calculator. Wealthy families, those with special-needs family members and others in unique situations will also have different insurance needs. Most insurance websites offer calculators to help consumers decide how much coverage to take. The consumer website lifehappens.org also offers step-by-step guidance on choosing insurance, along with a needs worksheet.
Get multiple free quotes. Consumers can also get free quotes from multiple insurers from sites such as My Family Insurance, InsuranceProviders.com and http://myfasttermquotes.com/, which are independent-agent sites for Barnes, Ohman and Acker. Keep this in mind: Getting a quote doesn’t obligate you to work with a particular company or insurer.
Choose the right advisor. It’s also important to understand that hiring an insurance agent or financial planner is just like any other relationship: You want someone who works best for you and inspires comfort. Hamilton said she not only interviewed potential reps this last go-around, she also requested references and asked them about their company philosophy before making a decision. LifeHappens suggests that consumers use referrals to find an insurance provider.
Seek out independent agents. When it comes to actually choosing an agent or financial planner, Ohman suggests looking into independent agents that aren’t tied to a particular insurance company. That’s because a “captive” agent can only recommend those products that his/her company provides, whereas an independent agent can recommend any number of companies. That doesn’t mean they don’t have your best interests in mind, just that they aren’t able to provide customers with options outside their company offerings.
“The only products that they know about, the only products that they’re even allowed to bring to your attention,” Ohman said, are “their own products.”
Understand what it means to be a fiduciary. Another thing to consider is whether the company or adviser you’re working with is a fiduciary. “One of the big advantages you get with working with an insurance agent who has that CFP designation is that they are supposed to be working as a fiduciary, which means they put your financial interests first,” Ohman said.
Those who hold a CFP designation like Ohman are expected to provide fiduciary care to their clients. It’s also perfectly OK to ask your agent if he or she is, in fact, a fiduciary.
By the way, this doesn’t mean that other agents can’t or won’t provide clients with the type of insurance that works best for them. But don’t hesitate to ask if they’re paid on commission and whether a bonus or trip is tied to a particular transaction.
Check the insurance company’s ratings. Once you get a recommendation, he says, make sure the company has at least a A rating or better from independent agencies that rate companies’ financial strength. There are four independent agencies that provide this information: A.M. Best, Fitch, Moody’s and Standard & Poor’s. Do your research and find the ratings from each of the four agencies, because some companies may highlight a positive rating from one agency and play down a lower rating from another agency.
Trust your gut. Barnes said regardless of whom you choose to represent your insurance needs, make sure you have a level of comfort.
“Don’t be discouraged, there are some great independent agencies,” he says. “If it doesn’t feel right during the process, trust your gut.”
That means continuing to be open-minded, but also not allowing yourself to purchase an insurance product you don’t want or can’t afford. During that first meeting or so, Barnes says the agent should spend time getting to know you and your situation without necessarily trying to sell you on a product.
Similarly, Acker says it’s OK to question your agent to make sure you’re getting the best policy for your needs and lifestyle: “Don’t be bullied into buying what someone else says you should buy.”
For her part, Hamilton says she also looked into whether companies were commission- or fee-based. That’s because a fee-based company will charge a set rate, which can ease the worry of having an overzealous rep who may offer expensive products to boost his or her commission.
Because many good policies also offer a conversion option, you’re not “stuck” forever with something that doesn’t actually work for you. That means you have the option to change policies, as Hamilton did. Some consumers also choose to buy additional policies down the road.
But, and this is key, you shouldn’t let uncertainty or the fear of overpaying keep you from getting at least a simple policy.
“Think about today — the immediate need; protect that right this second,” Acker says. “Then that gives you time to work on your financial planning. Then you can figure out if you want to keep the insurance.”