The
dangers of underinsuring life insurance
needs is just a lesser version of having
no life insurance at all. We have
already spoken about the issue of
over-insuring
(which you won't find from many life
insurance agents) but the opposite is
equally pressing. It's important
not to let short term cost
considerations jeopardize your families'
future financial health so let's look at
how to avoid underinsuring term life.
Underinsuring usually results from two
different causes. The first is to
not be able to adequately estimate what
your needs are in the first place and
the other is to "go cheap" on term life
and hope for the best. Both are
equally dangerous so let's tackle these
first.
How much term life do you actually need?
This is tough because it requires you to
look into the future...always a daunting
task. First, we need to quickly
recap what term life is designed to do.
The best way to think of it is that term
life is about
replacing lost
income over a long period of
time. Underinsuring usually occurs
when the amount chosen does not truly
match what is being lost or the length
of time is not adequate to carry your
dependents out to a point where they are
financially stable. For the first
part of this equation, how much term
life should you consider?
We
have provided our handy
term life
insurance tool to help
provide a preliminary estimate.
Essentially, you want to take the amount
of income you make each year now and
project it forward over a period of time
that accounts for the most costly years
in terms of raising a family or
providing for a loved one. This
can be 10 years for older couples or up
to 30 years for new families. It
really depends on your personal
situation. Where many people go
wrong is to forget the power of
inflation to wear down the purchasing
power of your money over longer periods
of time. Our term life estimator
tool takes this into account. To
give you a quick example, if the average
inflation rate over the next 10 years is
4% per year, your money towards the end
of that period will be worth only 60% of
what it can purchase today. For
example, a meal that costs $10 now will
likely cost $14 10 years from now in
equivalent dollars. That may not
seem like a big deal but when you're
looking at $50K being eroded to $30K
after 10 years, you can see where the
issue is. The longer the period of
time, the more powerful this effect can
be so make sure to include this in your
calculation. Simply missing the
effect of inflation is underinsuring
life insurance in itself.
The other way people underinsure is to
choose a period of time that's not
adequate. If you have young
children and you choose 10 years of term
life insurance, the protection will end
right when things are starting to get
very expensive. College is right
around the corner and who knows how much
that will cost at the rate we're going.
Yes, you can always buy more coverage at
the end of the 10 year window (assuming
you can qualify based on health then)
but at a much higher cost since age is a
huge contributor to cost. It makes
more sense to buy a longer term that
adequately addresses your time needs now
at a much lower cost per dollar of
protection.
Going back to our original two causes of
underinsuring life insurance, short term
cost savings at the expense of long term
stability is rooted in the same error
that causes people not to buy life
insurance at all. If you see two
plans and one is $75 per month while the
other is $100 per month, you start to
think of all the things you can do with
that additional $25 per month.
That's human nature and especially true
for Americans where the future is some
nebulous, far-off realm not to interfere
with today's pursuit of happiness.
However, let's use the same inflation
that degrades our benefit to address
this issue. Term life insurance is
great because the premium is fixed.
This means you will pay the same
$100/monthly for the length of the
policy. Assuming a 10 year period,
that $100 is really being eroded by an
average of 4% annually. So in year
two, it really feels like $96, then $92
in year three and so on. By the
end of the term, you feels like $60 in
terms of what it can purchase.
It only hurts now! Use this tool
to help you avoid the dangers of
underinsuring your term life needs.
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