Insurance is among the least sexy of financial instruments. You pay your premiums to safeguard against some possible disaster and then hope you never get your money's worth. That's some value proposition, right? Throw in the issue of your own mortality, and you might be inclined to ignore the need for life insurance entirely.
And you wouldn't be alone in that mindset. According to a recent study by New York Life, millennials are exposed to financial risk because they don't carry enough life insurance. The survey revealed that millennials have, on average, $100,000 in life insurance coverage. But this group also estimated they'd need $452,000 to get by if a household breadwinner passed on. That's a coverage shortfall of $352,000 -- which is 60% greater than the coverage gap for the general population.
As much as you might not want to address your life insurance needs, this backup system could play an important role in your family's financial security. If you have a coverage gap to close, here's what you need to do first.
1. Assess coverage needs
In its most basic form, life insurance provides a tax-free, lump-sum payment to beneficiaries if the insured dies while the policy is in force. Those beneficiaries can use the money however they want. Most commonly, though, life insurance payouts are intended to cover the insured's funeral expenses, pay off household debt, and replace the insured's income temporarily. Ideally, the death benefit helps family members keep their home and maintain their lifestyle even after the loss of the primary breadwinner.
The question for you to consider is, how much will that cost for your family? To land on the right coverage level, start making a list of your beneficiaries' needs after you're gone. An easy starting point is funeral expenses. According to Choice Mutual, the average funeral cost in the U.S. is $7,360. Add to that any debt balances that need to be repaid, including the mortgage, to ensure your family members don't get displaced. Then consider the loss of your income as well as future expenses. For example, you might want to provide college tuition funds for your kids or a comfortable retirement fund for your spouse.
If your wish list has a high price tag, assign priorities to each item. Once you start shopping for rates, you can adjust your desired coverage level if it proves to be unrealistic.
2. Understand temporary versus permanent coverage
Life insurance can be temporary or permanent. A temporary policy is what's called term life insurance, and it covers you for a specific time period -- usually between 10 and 30 years. During the policy period, you pay the premiums, and if you die, your beneficiaries get a death benefit. Otherwise, the policy simply expires.
Permanent life insurance comes in a few forms, such as whole life, universal life, and variable life. These each have their own complexities, but all share some basic features. Namely, permanent life policies remain in force indefinitely, assuming you keep paying the bill. They have a fixed premium and stated death benefit, and they build cash balances that you can borrow or withdraw later.
Of the two types, term life policies have substantially lower premiums. Nonsmokers between the ages of 20 and 40 can expect to pay $25 to $40 a month for a 20-year term life policy with a $500,000 death benefit. On the other hand, a $500,000 whole-life policy at age 30 costs about 10 times more, with monthly premiums of $350 to $400.
3. Decide how life insurance fits into your overall financial strategy
The right life insurance policy for your situation depends on where you are financially today and where you plan to be financially in the future. Term life makes sense for younger, less established households as a financial stopgap of sorts. It protects your family in the immediate term and gives you time to grow your savings, pay down your mortgage, and save in your kids' college funds. As you work toward those financial goals, your family becomes less reliant on that death-benefit payout.
A permanent life policy is more expensive but does offer something in return for your payments: a death benefit that will eventually get paid out, plus the accumulation of cash value. If you are really good at saving money in your retirement plans, the cash value piece might not seem worth the extra cost of this type of policy.
Still, saving is hard, and you might like the idea of using insurance to supplement your retirement strategy. If so, you should move on a permanent life policy sooner rather than later. These policies have fixed premiums, and those premiums are lower when you're younger.
4. Comparison shop
As with any major purchase, plan on shopping around for the best rates on the type of coverage and death benefit you need. You can do this by contacting insurers directly or working with an independent agent. If you prefer to work with an agent, know that they work on commission. You'll want to be on alert for advisors who are steering you toward the most expensive policies.
For each prospective insurer, you'll need to complete a detailed application and provide results of a recent physical health exam.
Don't ignore your life insurance coverage gap
Life insurance isn't exciting, but it might be necessary to keep your family afloat if something happens to you. The most affordable path to closing your coverage gap is a term life policy, combined with disciplined savings in your retirement plans over time.