Insurance Myths Debunked Part 2 – Life Insurance

Last week we took a close look at some insurance myths, mainly car insurance myths. This week I am hoping to shed some light on life insurance myths, contradictory to what most believe life insurance is an important part of your financial plan and understanding some common myths can go a long way in your decision process.

It’s Better to Invest Than to Buy Any Kind Of Life Insurance
When I used work in the life insurance industry this would always be the number response to life insurance and it is a very dangerous myth. Although this maybe a valid reason in the future for not having insurance, at the early stages of your accumulation phase life insurance is important. Chances are you have a mortgage, maybe student loans and other consumer debts at the early stages what if something were to happen to you today or in couple of months? Your investments would not be anywhere close to cover the debt obligations left to your family. Until you reach the breakeven point you will need some sort of life insurance.

I Should ALWAYS Buy Term and Invest the Difference.
Personally I believe most people are sufficiently covered with term insurance, however not ALWAYS! There are cases when permanent insurance is needed (estate equalization, taxation, funeral cost etc). In these cases term insurance will not provide sufficient coverage for your needs.

Life Insurance Won’t Pay If You Commit Suicide
This myth has been brought about mainly by movies; the fact is that suicide is often not directly excluded from life insurance policies. Often there is an exclusion period for suicide; in Ontario (and most of Canada) this period is two years. If you commit suicide within the first two years of your policy inception then no payout will be made, if it is past the two years then your full face value is paid out (assuming everything else is remains the same).

All Life Insurance Policies Are the Same
“No need to read my policy – they are all the same, if you die your beneficiary will get paid.” You should always read and fully understand a contract you sign, although the concept of life insurance is simple not every contract is the same. Some have certain exclusion, some term policies are renewable and convertible while others may not be and so on. The auto insurance industry is highly regulated and policies are standard, this is not the case with life insurance policy. Read through your policy when you receive it and ask the agent questions if things are not clear. Also you need to make sure that all the information on the policy is correct such as the insured’s name and the beneficiary’s contact information.

Insurance Agents Can Determine Your Insurance Needs
Most life insurance salespeople are looking out for their client’s best interest, however remember that most get paid a commission and this can sometimes create a conflict of interest. Do not rely solely on what your salesperson advises, determine your own needs prior to speaking with insurance agents this way you’ll at least have a rough idea of how much you’d need. If you are unsure about how much you need see this post on some guidelines in determining how much life insurance you need.

Other Resources:

Here are 14 tips for purchasing life insurance.

Check out Clarifinancial for life insurance quotes from multiple agents and all anonymous.

14 Responses to Insurance Myths Debunked Part 2 – Life Insurance

  1. This is a pretty good set of myths. #2 mirrors my own conclusions about permanent life policies, which is that they come into their own when you have particular estate planning issues to solve or you are maxing out all tax-advantaged retirement options and still want to put even more away.

    The other surprising thing, along with covering suicides after two years, is non-contestibility after two years. In my state, if your policy has existed for two years without being canceled by either party and without the insured dying, the policy can no longer be contested on the basis of the application. In other words, if you left something out of your history in anything but the most egregious fashion, and it comes to light or is even what ended up killing you, it won’t matter. I believe they pretty much have to show intent to defraud – not just prove that it was pre-existing or even just that you knew it was pre-existing. I didn’t hide anything, but this still gives me much better peace of mind.

  2. @Ethan you hit it right on the nose with the contestability period and this post does a great job a addressing the suicide myth. I hear this all the time and try to correct people but maybe it’s better they don’t think it’s covered? We don’t want to promote anything now do we. There was an article I read recently (sorry I don’t have the link) that mentioned people throwing themselves off of buildings if the Senate lets the death tax expire (which they are on track to do). You add in the realization that your life insurance will pay out and our society could have a problem.

  3. @Daniel, I hope it clarified things for you, hope you have no such plans!! 🙂

    @Ethan and @EW thanks for bringing up the non-contestibility clause, it is a very important part of the life insurance policy!

  4. Ray, please give an example of “cases when permanent insurance is needed (estate equalization, taxation, funeral cost etc). In these cases term insurance will not provide sufficient coverage for your needs.”

    Insurance benefit payouts are just money. Assuming someone qualified for the same level of coverage (eg, $500,000 permanent vs $500,000 term), how could the term insurance not cover the person’s needs, and at a significantly lower premium?

    If a person needed more money for funeral costs, estate planning, etc, they could raise their coverage with term insurance just as well as they could with permanent, and wouldn’t need to have the cash value accumulation of permanent insurance, correct?

  5. @Ethan, Thanks for making a really interesting point! however if insurance companies know you can do this, can they not rewrite their policies?
    A really helpful article! Thanks (I also wrongly assumed that life insurance did not cover you for suicide!)

  6. @Alice, I believe the non-contestibility feature is required by state regulators in many places. Personally I prefer the state to stick to contract enforcement, and to let individuals decide what contracts to sign. But if we’re taking regulation as a given then I think this is a smart use of it. The single worst result in life insurance is non-payment after a death, and this regulation appears to have the effect of reducing such outcomes at the cost of higher premiums and new-policy costs.

  7. Ray, good post on clearing up some of the myths out there.

    Steve, it seems like Ray is saying that it won’t be sufficient because term insurance is guaranteed to be there when you die (i.e you die in year 21 of a 20 year term policy). But I hear what you are saying – $500k is $500k!

  8. @Jason, Thanks for the clarification. I’m not sure why I didn’t see it before. I guess I tend to think of life insurance in terms of income replacement, and after the end of my 30 year term policy, my retirement and social security survivor benefits would cover my funeral and continuing income for my spouse.

    Anyway, I see Ray’s original points about estate equalization, etc. with the point being if you need to have assurance that a large tax-free payout will be available regardless of how old you are when you die, then a permanent life policy might make sense.

  9. @Alice: Ethan pointed it correctly these are placed by the regulators to protect consumers, so companies don’t have a whole lot of options there.

    @Steve: I apologize for the confusion, I was referring to the time period as Jason pointed out correctly.

    Term policies are perfect for covering debt and fixed term needs, but if you need it for funeral costs or estate equalization you do not know the time frame it is needed for so a permanent policy would be the wise choice. Like I said previously term is sufficient for majority of the cases.

  10. Two of the reasons stated to possibly buy whole life as opposed to term do not apply for most people, and are mutually exclusive.

    Taxation – Even with the estate tax returning next year, the floor for taxation is still far higher than the estate of most folks.
    Funeral costs – It is much better to just put a little extra aside during your life (say, using the difference between term and whole life premiums) and save for the funeral costs that way. Your term life can cover funeral costs during your productive years, and your savings can cover it during your retirement (after you have presumably let the term life lapse.)

    Somebody that needs whole-life for taxation reasons is rather unlikely to need insurance to cover a funeral.

    Yes, whole-life has some VERY limited situations in which it is appropriate, but far more people buy it than fit those situations.

  11. IF you start your investment in time there is no need to whole life insurance later in life, because your savings and investments accumulated enough to cover your taxes and funeral cost.

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