OMG, Life Insurance WTF?

August 26 2013 | Guest post by Dara Strickland

Dara Strickland has helped you with legal issues and weddings and how to have hard conversations. Now she wants to give you the lowdown on life insurance.

By: DuncanCC BY 2.0
It's such a simple thing, really, usually just a box on a form where you write a name after the HR department bothers you about it. It may be one more of the things on your to do list, or you may have done it already.

I'm talking about the epically unromantic act that is designating a beneficiary for your life insurance. At least, it appears that way on the outside — what life insurance can do to take care of the people who depend on you can mean the world.

In my work as an attorney, I find that more than 80% of my clients have life insurance but few understand how it actually works.

So here are the Life Insurance basics…

Life insurance is a contract

You pay your premium to the insurance company, they agree to pay out a certain amount of money to the person you have designated (your "beneficiary") when you die. Premium costs are based mostly on how much of a risk the insurance company is taking that they will have to pay the full amount soon or at all.

Life insurance comes in two general flavors, whole life and term:

  1. A term policy will pay out if you die within a certain time frame, which may be as definite as "20 years" or as loose as "as long as I work for X Company." Under 30 and don't smoke? The monthly premium on a 20 year term policy probably costs less than a weekly latte habit. Over 60? You may have difficulty getting life insurance at all and the premiums are going to be higher.
  2. Whole life is certain to pay out when you die, no matter how old you were when you got it or how long it takes for you to pass. The premiums for this type of insurance are higher because there's no risk for the insured person. Why would life insurance companies take a bet they're certain to lose? Because the higher premium gives them immediate access to funds to invest before the final pay out.

There are two reasons to get life insurance:

To replace your financial contribution in a partnership when you're working, or to pass money tax-free when you're retired.

Financial contribution to partnership

Sounds like it can't be anything but a business relationship, right? Yes, life insurance is an incredibly valuable tool to help a small business continue or wind down gracefully if a key person passes away. For most people, the financial partnerships they have aren't business matters at all, but family matters.

My fiancé recently realized that if he died, the student loans his parents co-signed would not be forgiven and they would suddenly be responsible for the payments instead. A life insurance policy to cover the amount he needs to pay to satisfy the loans over the period of time he's repaying them could prevent that from happening.

Shared mortgage
One of the biggest financial partnerships many people have is a shared mortgage. Would your family be able to pay it without your salary? What about the regular non-contract costs of raising kids or caring for elderly relatives? These are all financial partnerships you have that might not be able to continue if you can't contribute money from your wages as planned in the future.

For people who are no longer working

Life insurance can be an excellent way for wealth they already have to go directly to the people they want to have it without having to go through the courts, other family members or — in the United States — being taxed.

The two biggest problems I see with life insurance in my job:

  1. People don't have enough life insurance.
  2. They don't have a good plan for where it's going to go.

Many of my clients who are working have an amount of life insurance (usually through their employer) that will cover two, maybe three times their annual salary. When you look at it on paper, that's a lot of tax free money! When you think of how long your family could get by paying current bills with absolutely no financial contribution from you, though, it disappears fast. Ask an insurance agent about more coverage. Seriously.

Making a plan for where your money will go

The part that insurance agents don't normally deal with is in making a plan for where your insurance money will go — and that's where you want to talk to an attorney. Almost all of my clients who have a partner and children have their partner listed as the primary beneficiary and their children listed as secondary or contingent beneficiaries. This means the children will receive the payment if the partner passes away before or at the same time as the insured person. It's a plan that makes sense that can also backfire with terrible results.

Real-life scenario, not uncommon: Your partner is driving, you are the passenger, you have a $100,000 life insurance policy with your partner as the beneficiary. Partner runs a stop sign and you are killed in a collision with another car. Your insurance company dutifully pays out $100,000 to your partner… just in time for the money to be taken by the other injured driver in the resulting lawsuit. The insurance money never gets a chance to take care of your family the way you had planned.

Change up the situation. You and your partner are both killed in a car crash, neither of you is at fault, your children are the contingent beneficiaries of your $100,000 policy. Now, no insurance company is going to write a $100,000 check to a six-year-old. The money will be available for a legal representative of a child to use on his or her behalf until the child is an adult, typically 18 years old in the U.S.

There is such a thing as a life-ruining amount of money

At 18, I had it together as far as a plan to go to college and law school, no credit card debt, responsible spending habits, reasonable car. Do you know what I would have done with a check for $100,000? I don't know what I would have done with all of it, but there would have been at least two motorcycles with my name airbrushed on them. Age isn't any guarantee of maturity, but it's hard to see the mundane things you might need money like that for in the future when you haven't lived without other people taking care of at least some of those details.

A good estate plan, put together with the help of an attorney who understands the benefits and potential pitfalls of your life insurance, can protect your family and make the most out of this useful tool.

  1. Excellent post. I tell people these things all the time (my aunt was a lawyer who died suddenly and had no life insurance). People just think I'm ridiculous or morbid. My been there situations (including a few friends who passed in their early 20's) don't even seem to help. I hope this saves some people some heart ache.

    If your partner dies, will you be going into work? How will you pay your bills if you don't? This is the way to go. Not to mention the costs of funerals, services, and 'clean-up' of bio-hazardous materials (your responsibility, btw).

    • Thanks for the kind words, Andrell!

      I'm hoping we get some comments from Offbeat Homies who are insurance agents as well, since I really just skimmed across the surface of the life insurance issue. All I can say is, keep talking to your friends. They may not be ready to hear you the first time, or even the tenth time, but the biggest challenge I find for people putting together the right plan for their family is lack of knowledge, not lack of desire.

      And no kidding about catastrophic clean-up. If you've ever seen the movie "Sunshine Cleaning," I'd say that part of it is fairly accurate.

    • My family dealt with a horrendous money debacle after my grandparents passed so my parent s have always been very upfront about money and health issues. We all have our own policies and living wills in case of injury or incapacitation. It blows my mind that people still have this attitude that talking about end of life planning/financials is weird or morbid. By refusing to deal with the possibilities of an untimely death all they are doing is putting their loved ones in a very tight spot and passing the buck, responsibility wise. I think adults need to grow up and realize that we'll all die but we can at least be prepared for it. There is no way that I would ever leave my partner with a mountain of debt and absolutely no plan…that would be the worst time for him to have to deal with money issues. We're both still young(27, 30) but I've already begun looking at places for burial and seeing the cost of deposits…there is no way that I'd leave that burden to my family when they are grieving.

  2. How timely! I was just thinking about checking on my life insurance policy and this post was super useful. It's definitely something I don't think much about, esp. as i've only had life insurance for about a year and half. Definitely some great stuff to add to our family discussion about money.

  3. I was thinking about life insurance, too — maybe y'all can help me by playing devil's advocate.

    I have life insurance through my employer equal to one year's salary. Currently my wife and I both work full-time or a bit more, and our basic, cut-to-the-bone expenses are about half of my gross salary (we save the rest). So if I were to die tomorrow, my wife would receive enough to pay for at least 1 and possibly 2 years (I had no idea the payout would be tax free!) of living as we currently are, even without working. Consider that if she were working, even part-time, and because the overall costs would go down because there'd only be one person to feed/clothe/transport, the money would last longer. And she'd have access to all our savings. We don't have children yet, but are planning on starting the adoption process next year.

    Do I need more life insurance? I expect that I would want to look into larger policies if there were kids in the household (my wife would probably take time off, and there would be daycare costs on top of the food/clothing/etc.), but am I sufficiently covered until then? What situations do you foresee where that wouldn't be the case?

    • My husband and I both have policies through work but our financial guy suggested getting a seperate policy anyway just in case. Jobs aren't always forever and you want to make sure your wife, and potential future children, are covered in case something happens. He also told us to get it while we are younger because the premiums are lower. Something he said that really resonated was that we want to be able to grieve the loss of our loved one without worrying about how to pay the bills.

    • Congratulations on having the discipline to put so much away in savings! If you haven't already, you'll definitely want to take to a financial planner about how to make sure that savings makes some money for you, since interest on savings accounts is practically non-existent.

      Insurance policies through work are great, but they typically only cover you while you're employed or for a very short time thereafter. You'll want to check with your company's HR department to get the full story on it. I can easily see a scenario where your life insurance coverage through your employer will terminate, say, 3 days after your last scheduled day of work. You leave your current company to take a job with another company where benefits like life insurance don't start before a 45-day probationary period is over. It's only a very short period of time, but it's time when you aren't covered at all and there would be nothing to replace your income but your savings.

      If your benefits aren't actually a life insurance policy but are survivor benefits based on a legal marriage (many law enforcement officers and firefighters have these) and you're in a same-sex marriage, you'll want to be extra-careful. Cases like that are lighting up state Supreme Court dockets in states that don't recognize all marriages.

      • That is all good info, thanks. So if I leave my current employer or we get very close to having kids (the process may take a while), I should bump up to a separate policy. About how long does it usually take to make that happen? (Hypothetical: I'm let go without notice, and benefits run out at the end of the month.)

        • In my experience, it doesn't take long to get life insurance coverage, a few days at most if you're under 50 and are looking for a term policy.

          For your adoption, you'll also want to plan for it to take twice as long and cost twice as much as whatever you're thinking right now – it's always better to be pleasantly surprised than feel like you're slogging on long past the date it should have been done.

    • Get a separate plan. A year's salary sounds like a lot of money, but it's really not that much. A funeral alone could wipe out thousands of dollars. Not to mention this scenario: you get hit by a car and linger, disabled and unable to work, for 12 months before you die. Disability insurance would help with this, but I'm betting your partner would be in some serious debt before you went. Life insurance would help pay those bills after you go. Most people don't just suddenly die, they get sick first. My husband and I have two kids, so our situation is a little different, but we each have $1 mil+ insurance and we make a tiny fraction of that every year. We have term, so it's not crazy expensive to have that much insurance anyway.

      • I hadn't considered medical costs before death — that's something else that would need to be paid for. Makes sense to me.

  4. Thanks for this helpful post! I think we need to look into coverage beyond what my husband and I are getting through work.

    Is there a way to avoid that terrible at-fault car accident scenario you outlined?

    • That can be avoided with a very simple trust. If a trust, rather than a person, is the beneficiary of your life insurance, then a lawsuit based on the personal conduct of the individual (in this case, the negligent driver) probably can't touch the funds because they never belonged to the individual, anyway.

      I know the idea of a "trust fund" conjures up visions of idle playboy heirs wiling away the hours in Aspen chalets, but trusts are a basic tool that can be good for just about all income levels and probably cost less to set up than you'd think.

      I usually tell clients that a trust is like a robot. You build it before you need it and program it with what to do. It can hold property on your behalf (sidestepping the drawbacks of having a person be the owner) and then follow your instructions for how and when to give the property out.

  5. i would have been lost if my husband didn't have life insurance, and even then it went fast. he had forgotten to update the beneficiary when his parents transferred the policy to him (they'd gotten the policy when he was a minor), so they got the payout. lucky for me they're honest people and disbursed it to me immediately. i wound up having to sell our house a year or so later. we'd only been there a couple years, so there was no equity and i had to take a pretty hefty loss on it. i probably would have had to foreclose if not for that money.

    • Carly, I'm so sorry for your loss and glad your in-laws were able to set things right. One of the great things about insurance is that it pays out to whomever is listed as a beneficiary and it's nearly impossible to challenge – it's been one of the best ways for same-sex couples to take care of each other and pass assets without family interference for 100 years. Unfortunately, the other side of that is what you experienced. Doing the right thing by giving someone else life insurance proceeds can also take something that was supposed to pass tax-free and subject it to Federal Gift Tax (US only, ask your own lawyers and accountants, international Homies) or seriously interfere with an elderly parent's state-subsidized healthcare benefits.

      I also see this frequently with people who never changed beneficiary designations on retirement funds and insurance policies after they divorce. The worst.

  6. Thanks so much for the great post! I ended up getting life insurance through my work for the same reason the author's fiancé did (tons of money owed on student loans that my parents co-signed for and couldn't possibly pay all on their own) though now I'm wanting to increase the policy money as even good insurance doesn't cover everything a doctor may use to try and save/treat someone who's very ill or had been in an accident (a ride in a Life Flight helicopter is several thousands of dollars) , not to mention funeral home bills etc. Keep the good advice coming!

  7. This is really interesting. I just got married and have been thinking about all of the "adult"-like things to do, like considering life insurance. I have only the super basic, default plan through my job which would cover a wopping $40,000. Perhaps need to consider looking into more coverage.

  8. Ok, weird question:

    Which would be a better choice or more prudent investment? Life insurance or health insurance? I don't have a budget for either, but should probably have both. One would be a stretch, and both would be impossible. Any thoughts? (I'm in the US in California).

    • Health insurance, for sure. Even the most basic care is incredibly expensive and if you have any kind of emergency you could easily end up owing 10's of thousands of dollars. I went through a time in college when I didn't have it and it was terrible. I desperately needed to go to the dentist but couldn't afford it. I would get blinding migraines constantly because I needed prescription eyeglasses but, again, couldn't afford it. Plus, I couldn't go to my regular gynecologist and getting birth control was such a hassle. Not to mention I lived in constant fear of getting sick or having some kind of accident which would ruin me financially. Just a simple broken bone would have left me with massive bills and my credit could have been decimated. It sucked and made me wish constantly that I had had the good fortune of being born a Canadian.

      • Here's the other thing. I have needed health care before (once an ER visit, other times gyno etc). For regular doc stuff I can just go to the free clinics around, and the ER visit was free because I signed some paperwork stating I am below the income level for the poverty line (true). I don't know of any such programs for life insurance needs.

        I have also gotten MRIs and other services at a fraction of the cost because many providers will offer a "cash price" that is incredibly small compared to the insurance cost. Still not anywhere close to the likely actual cost of services, but a $200 MRI is pretty good and less than a month of health insurance.

    • Health insurance. You can only die once, but you can get sick (at the cost of hundreds of thousands of dollars) again and again.

    • i agree with the other two answers, but the costs are not always comparable. For us, enough life insurance to cover our mortgage/business debts in case myself or my husband dies (we own/operate a farm together) is about $56/month. Health insurance with decent coverage in our state for both of us would have been $1500/month or more . Even a plan for just my husband with a $5,000 deductible with NO routine coverage was about $400.00/month. That may be changing for people in our income range with the upcoming affordable care act, but the choice between 50 bucks and 1500 bucks was an easy one.

  9. Dara, thanks for this post. We've been talking about life insurance lately so it's very timely. However, I must admit that the more I research insurance companies, the less confident I am that any policy we purchase will actually pay out if/when they need to. It seems all I find are hundreds upon hundreds of individuals reporting that they faithfully paid their premiums for years only to be denied any life, auto, or homeowners' claim that had to be made, and it really makes me feel like hiding money in a mattress. Could you possibly recommend some companies you've dealt with personally or received good feedback for? I know that must be a difficult question considering your line of work, as you may represent the client v. insurance battle on the regular, but it would be great to know if any can be trusted.

    • Great question. First, separate out property and casualty claims (like houses and cars) from life insurance claims. I'd say it's common to see a P&C claim go unpaid/contested/underpaid for the out-of-pocket cost, but I've heard of very few challenges to getting life insurance payments.

      I usually deal with long-time established insurance companies like Prudential, Mass Mutual, New York Life, MetLife, etc. because they've been around and aren't going anywhere. I'd say the key, though, is having a good insurance agent who will have your family's best interest at heart instead of a sales quota, and that can be hard going directly through these bigger companies. I've had the best luck finding that kind of client focus with insurance brokers or independent agents, who earn commission on their policy sales but aren't tied to a particular product. My guy is Aaron Unell with Insurance Consultants, Inc.

      http://www.insuranceconsultantsinc.com/insurance_personal.asp

      Aaron once called me to get directions to the municipal night court of some terrible place I wouldn't go on a dare at high noon on Sunday. He was personally picking up a car insurance client to drive her to her court date there to get her drivers license reinstated. Not a lot of agents are like Aaron, but he's the kind you want to find.

      One of the ways insurance companies cut overhead is to make things automated. If the most important thing to you is price, then it's a great thing. If you want someone who will actually look through the policy with you and answer questions, you need a person. If you're really lucky, you have an Aaron.

    • I used to be a life insurance agent (now I only do auto and property). The best advice I can give you for helping to ensure that a company will pay upon your death, is to make sure the company underwrites the policy when it is set up.

      What that means is that they go through a very detailed application regarding your health and family history which must be reviewed by their underwriting team before they issue the policy. They may also do a short medical exam in advance, depending on how much insurance you are purchasing. Be brutally honest when answering the questions. For example – if they ask if you're a smoker. You're not really, but you've occasionally had a cigarette or two while out partying. Tell them.

      People who have claims denied either omitted information or they had a a policy where they answered only a short questionnaire and the file wasn't underwritten until after they passed – and then more information came to light that wasn't disclosed at the time of application.

  10. This is so timely. If I could just add one more thing: Remember to change your beneficiary!

    This is not life insurance, but the same general principle. My dad left behind an IRA when he died, and I recently found that he never updated the beneficiary information, so it goes to a woman divorced over 30 years ago. I wanted to go back to school, and to set up a scholarship in my dad's name with that money. Now I get to ask for it nicely from a woman I've never met, who can totally choose to keep it if she wants. That's not what my dad would have wanted.

  11. Dara's advice is well written, thought out, and very practical. Thank you for this.
    As an insurance broker who has (recently) married another insurance broker, I've seen these heartbreaking scenarios play out all too often.

    After reading this guestpost and it's replies, I have additional info that some of you may find helpful:

    The life insurance through your employer is usually a group life policy. That means that when you are no longer a part of the 'group,' or the employer, you are no longer eligible to keep that policy. However, in many cases, the insurance company will let you convert the policy into an individual one. Contact them directly and have your group/ID #'s ready.
    Usually, the benefits from these policies are enough to cover basic funeral/burial services. The average cost of a burial funeral in 2012 was $8,500. The basic cremation funeral service cost an average of $3,700. (according to efuneral.com) Of course, these can vary depending on the area you live. These prices do not factor in costs like cemetery plots, a monument/headstone, flowers, or other extras.

    It's great that so many of you thought to insure your parents against your student loans. You are the perfect example of why you don't have to be married or have children to need life insurance.
    We advise our clients to buy more insurance with each life milestone: spouse, house, kids, and if you can afford it, investment.
    Spouse: You want to make sure they can pay the bills or continue to work without you. Consider getting more coverage on the spouse that contributes more financially. Make sure that the insurance on the spouse that does the majority of the house work and childcare is enough so that the surviving spouse can pay for assistance. Not everyone has a large support system for childcare and keeping up with a house, especially when you have to work 40+ a week.
    House: You want to make sure that if you are gone, your spouse can afford to stay put. Hard enough to deal with losing your partner, losing your home after that would just make matters worse.
    Kids: You want to make sure they can continue their educations. Losing you means losing a large portion of their potential tuition payments. And, kids are expensive in general. Clothes, activities, braces, all those things are hard to pay for on one income.

    I've seen same sex couples, living in non-recognizing states, avoid the topic of life insurance altogether. You don't need to do this. If the insurance company cannot allow you to list your partner as the beneficiary, just use this work around:
    Get the policy and list a parent, sibling, business partner, someone who you trust and can qualify as having an insurable interest in you, and make them the beneficiary. (for now)
    Once the policy is in force, you are allowed to change the beneficiary to any person you like, anytime you like, without having to justify or explain your needs for the coverage.
    Also, I haven't considered it until right now, this would work for poly couples as well.

    In addition to Term and Whole life insurance, there is a third type of life insurance policy available, called a Return of Premium Term. It works the same way a regular Term policy does, with an additional benefit. If you outlive the policy, the insurance company pays you back the entire premium. All the premiums that you paid will be returned to you. No interest is paid on the premiums, but you have essentially received free life insurance for the length of the policy.
    These policies are more expensive than regular Term plans, but are usually cheaper than the Whole life plans.
    Please note that I am not endorsing one product over another, just providing a third option. Not all plans are available in some states. All decisions involving the purchase of life insurance should be discussed with an agent or broker who is licensed in your state.

    • Terra, thank you so much for your thorough comment! I was really hoping an agent or broker would chime in with advice, since I can only talk about the small slice of life insurance considerations that intersect with what I do.

      When do you need to review your estate plan, insurance coverage, and beneficiary designations on IRAs, 401(k)s, 403(b)s, CDs…BYOBs…? My rule of thumb is that if you have a life event where you might reasonably expect the people you work with to throw you a party to celebrate, it's probably time. So, wedding, birth or adoption of a child, retirement, large promotion, milestone birthday – yes. Wedding anniversary, birthday ending in "7," small promotion – probably not.

  12. Thank you so much for this post! I recently started a family and life insurance is one of those big-scary-adult things that we know we need to deal with but have no idea about. This has definitely given me a good place to start.

    Also, I wanted to throw in a "THIS!" to your last section about not leaving a large, unstructured amount of cash to someone who may not be old/mature enough to handle it. I went to college with someone who had received a substantial payout from her mother's life insurance. She didn't even look into financial aid or fill out her FAFSA or anything – she just knew she had money and so walked into the bursar's office and wrote a check every semester at our very pricey art school. Between tuition and living expenses it didn't take long for the money to run out completely and leave her unable to finish school and struggling to make ends meet. Definitely not a position her mom would have wanted her to be in!

  13. Thanks for this post! This is a really good, concise overview for people who are thinking about life insurance and need to know the basics. I used to be a life insurance agent (now only auto and property), and it's amazing to me how people either don't understand the need for insurance or just want to put on blinders and pretend they'll never need it.

    My mom was smart and bought a small whole life policy for me when I was 5. My premiums will be $15/month for my lifetime and the policy will be paid up in full when I'm in my 60's. She also had the dividends from the policy reinvested, so what was $25k when she bought the policy is now worth close to $40k. On top of that, I have a large policy through work as well.

    Even though I'm single, if I died, my parents would still need to pay for my funeral, take the time to prep and sell my house and my car, and pay those nasty real estate fees. As well, I know for certain that my mom wouldn't be able to immediately go back to work. So I've left both parents enough that they could take a substantial amount of time off or even retire early.

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