Life Insurance Myths Debunked

Canadian finance blog Financial Highway is running a a financial mythbuster series, and the latest entry tackles life insurance.

One of his more surprising bullet points is that suicide is typically covered:

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).

The post also says it’s foolish to think you should divert your money to investments rather than life insurance, and to think that all life insurance policies are the same so it’s not necessary to read your individual contract.

What’s your philosophy on life insurance?

Insurance Myths Debunked Part 2 – Life Insurance [Financial Highway]

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  1. pop top says:

    My husband and I both have life insurance. I figure, why not? Even though we’re young, it’s still nice to have around in case anything happens. Plus it makes us seem like normal adults…

    • qwickone says:

      I have it through work and it’s only $50-100K, I think. I have disability insurance. I’ve heard if you’re young and have no kids, in particular, it’s way more important to have good disability insurance.

      • pop top says:

        I have mine through work too, but I don’t have long-term disability yet. It’s really expensive unless you have at least like 500 hours (or something) of sick leave, and I only just started here. Once I accrue that much time, I will get it though.

    • tbax929 says:

      I have it through work, and it’s twice my salary, which is way more than my fam will need if something happens. If I had kids, I’d carry more. I also have a small policy with SGLI.

    • chiieddy says:

      I have enough through work on myself to pay off our mortgage if I bite it (since I’m the main breadwinner this is very important) plus a little extra to pay for the funeral. I have the max out I can on my husband, but it wouldn’t fully cover our mortgage, but his next sign up period, he’s supposed to take care of that through his employer to make up the difference.

  2. travel_nut says:

    We’re young, but we have a house payment and a baby on the way. If (heaven forbid) something was to happen to one of us, the other needs to be able to pay off the house and provide for the kiddo. Plus it’s super cheap for people our age, and our rates are locked in for 30 years.

  3. Greg Smith says:

    I’m single with no descendants. I’m better off spending the money on women, drugs and booze than giving the money to some life insurance company.

  4. FatLynn says:

    I got life insurance because the monthly cost was less than the multi-line discounts I got on my car and homeowner’s insurances. I have no dependents, but it still pays off.

  5. coffeeculture says:

    It’s the responsible thing to do especially if you have other people (ie kids) that rely on you for income. Buy it cheap and forget about it basically…that’s what insurance is made for.

  6. npage148 says:

    My Wife and I have term life. We are mid 20′s, just bought a house and got a fair amount CC debt. I also have a butt load of student loan debt. So if anything happened to either of us, it would definitely bankrupt her and most likely put me under huge strain. Term-life for us was smart, it would get all the debt covered and the house, it was also cheap. Gotta take care of each other

    • TuxthePenguin says:

      Life insurance, if you have a mortgage, to me is a moral responsibility. When my wife and I bought our first house, I got enough to effectively pay off the mortgage as of the day we signed.

      But just as a note – if you die, student loans go away. Poof. Your wife is not responsible for them as long as they are truly student loans – if you consolidate into something OTHER than a student loan, she’s on the hook. Not to mention student loan interest is also tax deductible…

      • mac-phisto says:

        student loans don’t just go “poof!” the creditors make their claims against the estate & are paid based on what assets the estate holds. if the estate holds no assets, yes, they go poof! if the estate holds money to pay the debts, the estate goes poof! (it’s not quite that easy, but i’m sure you get the general idea)

        i think the first part of your comment makes sense: once you start building significant assets, it’s important to protect them with insurance, especially if you have debt that could impact the standard of living of your loved ones should you pass on.

        • thompson says:

          Not entirely. For Federal student loans (Stafford, ParentPLUS, GradPLUS, etc.), death of the student for whom the loan was taken out is grounds for cancellation of the loan balance.

          For private student loans, and for other creditors, your comment is absolutely true.

      • RandomHookup says:

        Only if you have a spouse or family who would be living there and your death would make an impact on their ability to pay the mortgage. I have a mortgage, but no life insurance. The building will still be there when I’m dead.

    • tbax929 says:

      Your wife wouldn’t be on the hook for your student loans.

    • wcnghj says:

      Unless the credit card debt is joint or you live a community property state, she is NOT liable for it.

      • thompson says:

        Even in community property states there are usually limits to how much creditors can “pierce” the estate and go after the surviving spouse’s property to satisfy the deceased’s debt.

        And any debt you brought into the marriage remains yours alone and the spouse is not obligated.

    • npage148 says:

      Hmm, that is interesting about the student loans. I was always told/under the impression that she would be. They are all federal/state loans. I need to check into that.

      Thanks!!

  7. tinmanx says:

    If you get whole life, make sure you keep track of what your agent is doing or not doing with your policy. My parents got a whole life policy many years ago, and the agent put everything into one investment and never touched it even when it was losing money for years. My parents did not speak english and just went with whatever the agent told them. They only found this out when the agent retired and they got a new agent who was shocked at how bad our policy was doing. The amount of the policy is now less than the money my parents put in. Their policy is now diversified into multiple investments, hopefully everything goes well.

    • ColoradoShark says:

      I’ll make it simpler. Do not get whole life. It it touted as a savings vehicle but it sucks as a savings vehicle. Get term life insurance only.

      • tinmanx says:

        Whole life does make sense for some, especially if you buy it early in life so the premium is low. Once your policy/investments get to a certain amount, the dividends or whatever from those investments will cover the cost of the premium.

        I know many people who have paid ~$600/yr for 10-12 years and now the returns on their policy’s investments cover the cost of the premium. So they paid a total of around $6k-7k for a $100k policy that will never expire until they do.

    • morgasco says:

      That sounds more like a variable life policy then a whole life policy.

  8. AllanG54 says:

    Term life is what people should buy. Whole life, universal life, anything like that is a waste of money. The premiums are about TEN times the premium for term and the benefits are nil except that whole life will pay if you die at 90 where term usually won’t renew after age 75. The only reasons to buy life insurance is if you have a family that needs looking after if you should die. Otherwise put your money to use in investments. By the way…the guy whole sells you whole life makes about 60% commission the first year so if your premium is $2000 he’s (or she’s) getting about $1200 of that. If you buy term they make a straight 6%.

    • morgasco says:

      I haven’t seen a term policy out there that only pays 6% for commission on the first year, they are all in the 40-50% range. So maybe some fact checking before ya post, since spewing out random numbers doesn’t help anyone.

  9. StatusfriedCrustomer says:

    Here’s another myth (from TV commercials): You should buy life insurance on babies to protect them.

    • JiminyChristmas says:

      The typical rationale for taking out life insurance on a dependent child is really just to pay for the funeral. This is often reflected in the coverage limits in inexpensive term life policies for a child, which are usually $5,000 or $10,000.

      • lisalouise37 says:

        both my children have life insurance. When they turn 20 they can either keep it at the low cost or cash it out. At that age (because we got it when they were born) the amount we have put in will have equaled out. We will not be paying for college or any other LARGE purchase (house, car) when they are older so this will be their money we set aside for them. Each child is only $15 a month – so $30 total – and that is the cost of one fast food dinner anymore. Cheap and easy.

        It is also the gift that keeps on giving since those rates don’t go up. I am 29 and just got life insurance. I pay so much more than that for half of the coverage because of my age. If my parents got life insurance when I was little (and I chose to keep it when it matured) I would still be paying the little amount my kids pay (well less since it would have been the 80′s when they got it).

      • Netstar says:

        I never understood the logic behind life insurance for children. If you cannot afford the funeral for a child, how can you afford to support a child and send them to college?

      • cluberti says:

        And technically it is a good idea – a good friend lost his son and had life insurance (I don’t know what it was, but enough to cover funeral/burial costs and some of the medical bills he had) and mentioned a few years later how it helpled them cope to not have financial worries about it on top of the other stresses of burying your child.

    • StatusfriedCrustomer says:

      Right – so it protects YOU, not the child.

    • morgasco says:

      I think they try to represent those policies as something to protect the child’s insurability while they’re young, and have no major health issues.

    • coffeeculture says:

      Yeah baby insurance is pretty much for funeral costs, but no TV commercial in their right mind would say something that explicit. Kind of like how maxi-pad or toilet paper commercials “ease up” on what they’re used for.

  10. Alex says:

    I agree that people with dependents should seriously consider life insurance, unless they have very liquid net worths. Even with such conditions, a policy would provide some much needed liquidity until estate matters are resolved.

  11. Eyebrows McGee (now with double the baby!) says:

    We haven’t done it and probably should now that we have a baby. On the one hand, we’re both earnings-capable with law degrees (although I am currently at home), so it’s not as crucial as it was for MY parents where my father was a high-earning professional and my mother was an at-home mom of four children with “only” a BA (now she’s got multiple masters, but that was later). On the other hand, we probably should have at least some insurance to help ease that burden if, God forbid, something happened to one of us.

    My husband has $100,000 through work which would be enough to carry us through a couple years, but I don’t have any, and I’m going to guess $100,000 isn’t considered enough when you have spawn.

    I should get on that.

    How much is enough when you have spawn?

    • Eyebrows McGee (now with double the baby!) says:

      Okay, I ran a calculator, and as long as I take a crappy job making well below market rate and my kid goes to a state school for college, I need an additional negative thirty grand in life insurance right now. :D

      I feel better already!

      • chiieddy says:

        The only thing you may want to consider is if both you and your husband die and your child is left in someone else’s care (grandparent, uncle, close friend, whatever). You should have enough to provide for the child without cutting into someone else’s budget.

    • henrygates3 says:

      We have enough on each of us, so that if something were to happen the other could pay off the mortgage, secure some college funds for the kiddo, and replace income for a few years. Fortunately I “only” have a BA so I’m unemployable, broke, and easy to replace.

      • Eyebrows McGee (now with double the baby!) says:

        I hope you didn’t take my “only” a BA as an insult but rather are being facetious … it was a different world in the 70s when my mom’s BA was taken rather less seriously than her MRS, which is why I put “only” in quotes. :) Today the life they had then — four children on a single salary with the at-home wife not terribly employable because of her matchy-matchy chromosomes — seems terrifyingly precarious to me now that I have a kid! Even if my mom had been able to find a job if my dad had died when we were young, his greater education and XY chromosomes gave him a lot more work options than she would have had (just about the only work she could find with her BA before she started having kids was secretarial), and there were far fewer child care options for working single mothers back then.

    • tbax929 says:

      Now that you have spawn, you definitely need more life insurance than $100K, assuming you want your spawn to be provided for if, heaven forbid, something happen to you and your hubby. Life insurance is rather cheap, and I’m often surprised by the number of people who don’t have it.

      Additionally, your hubby should be able to increase his life insurance amount through work for a nominal charge. My company pays 2X my salary, but I can increase that up to 5X my salary for just a few dollars a month.

      • FatLynn says:

        I assume that you and your husband often go places together, so consider the possibility of getting in a car/train/plane crash that takes both of you. Seriously, get it now.

      • cluberti says:

        Agreed – for about $30/mo, I can pay for ~$800K for me, $350K for the wife, and $15K for each dependant child. I don’t know about other people, but $30 a month is fairly cheap for what you would get if there was a death, or deaths, in the family.

    • kalaratri says:

      Between the two of us, hubby and I have enough to pay off our mortgage and (hopefully) have a little left over to put junior through college. Of course if both of us go at once, it’s more likely that the house would get sold and that money would go for juniors upkeep, but it will ease the burden on my brother who would get the kid(s).

    • AllanG54 says:

      Insurance companies recommend ten times your salary as “enough.” If you’re young and you buy term it’s not expensive at all.

    • mommiest says:

      I would add that if you were to die while your children were young, your husband might need to hire extra help to care for them while he worked. If he has a demanding job, and wants quality care for the kiddies, that could cost quite a bit. The stay-at-home parent should have coverage, too.

    • pmc1445 says:

      There are three generally accepted methods for calculating your life insurance need. The first is the Human Life Value approach (HLV), which tries to replace the “value” a spouse, (typically all of these analyses are done for married couples), brings to the marriage. (Monetarily, not emotionally or in other less quantifiable ways.) Second is the Financial Needs approach, which calculates what a family needs in terms of cash flow and then calculates how much insurance would create that cash flow. The third is the Capital Retention method, which is rarely used as it is considered too conservative. It seeks to create a lump sum of money that can replace all cash flows associated with the individual being insured while keeping the lump sum of money received for heirs. In other words, the insurance payment’s “corpus” is kept intact and never accessed, only interest earned is used.

      The HLV approach is easiest to calculate and I personally think is the most effective. It is calculated in four steps:

      1) Calculate how much the spouse you are insuring brings into the family’s income. If the spouse works, this is their gross salary less any costs they represent (in food, health insurance, car costs, etc…). If the spouse is staying at home, you calculate the cost of replacing the care they provide to the kids an home, typically by estimating childcare costs for a nanny or alternatives. Let’s call this figure “X”.

      2) Decide what rate of return you think you can achieve annually after taxes and adjusted for inflation. This is largely driven by how aggressive you are comfortable with being as an investor. Let’s call this “%”.

      3) Next, decide how long you’ll need to support the surviving spouse. Often this will be until the youngest child is out of college. We’ll call this “Y.”

      4) Using a financial calculator or Excel, calculate the present value of money you’d need to replace the cash flow “X” for the time “Y” at the rate of return “%”. This is calculated in Excel as “=PV(%,Y,-X,0)”. Note that the cash flow “X” is negative as it is being removed from your settlement every year. Also note the final 0 in the calculation. This represents the future value at the end of the time frame of zero, since the surviving spouse will no longer need support and the settlement will therefore be all used up. To use real figures, let’s say you can get 5% per year, for 20 years, and need $100,000 per year. Then, =PV(.05,20,-100000,0) and the result is $1,246,221.03.

      This provides a base figure to go off of. You can then add in extra lump sums to pay funeral costs, pay off the mortgage (if you do this, remove the amount of money that goes towards the mortgage from “X”), fund college education, etc… All of this is going to depend on personal preference and a cost/benefit analysis you have to do with yourself.

      Whole for this much money does tend to be prohibitively expensive, so Term makes more sense. Having an additional, smaller whole life makes sense if you purchased it in your early to mid twenties. In the event you’d purchase some, you can subtract the value of the whole life policy from the lump sum you need of Term insurance.

  12. Oranges w/ Cheese says:

    Here’s my question – my company offers life insurance for seriously cheap, so I picked up an amount equal to my salary. Granted, not much but enough to buy a coffin and settle stuff if I were to die. My boyfriend says its stupid because I don’t have anyone vested in me so its wasted money because no one would get it. Is this true?
    My parents wouldnt’ get it at all? I am single and I have no children, so I figured it would go to them.

    • kalaratri says:

      You should be able to name just about anyone as a beneficiary. We recently had to change mine because it was supposed to pay out to the ‘rents (they initially purchased it) instead of my husband..

    • ClutchDude says:

      State law comes heavily into play when no beneficiary is named.

      In Florida it comes down to this:
      1. Whoever you name as beneficiary.
      Failing that….

      1. Spouse
      2. Children
      3. Siblings
      4. Parents
      5. Cousins.
      and so forth.

      Name a beneficiary and make sure they know your wishes, via documents or living will.

      • ClutchDude says:

        Just thought I’d clarify:

        As part setting this up, you should complete a living will or some similar document so that in the event you are unable to make your own decisions, someone you appoint or has access to your living will, who might also be your beneficiary, will be able to do so without scrutiny.

        Nothing would be worse than to force a loved one to undergo scrutiny for “pulling the plug for the money” despite the fact you don’t want to be vegetable.

        However, naming the life insurance beneficiary(s) and the person you would appoint in your living will are not part of the same document.

    • tbax929 says:

      Your boyfriend is wrong. The policy would pay out its limit to whomever your beneficiary is. Vesting is a completely different concept, which you should educate yourself about, but it doesn’t apply in this case.

    • pop top says:

      Your parents would get it if you named them as beneficiary (I assume they’d also get it if you didn’t have a beneficiary named at all).

    • morlo says:

      Still seems like a waste of money unless your parents are financially dependent on you.

      • RandomHookup says:

        Enough for a funeral is always a good idea, if you don’t have enough in your estate to cover it. It’s a painful double burden for your folks to have to pay for your funeral, too, though most would do it without a thought.

    • Scoobatz says:

      Just a suggestion. Don’t buy any life insurance from your company. The policy is null and void once you leave or get terminated. Take whatever they give you for free, then purchase additional term life insurance from a reputable company that will stay with you no matter what. Generally, 10X salary is a good estimation. And, remember, term life insurance is available for 20, 25, or 30 years. Just because you may not have kids now or a big mortgage, keep your future in mind so you can prepare and lock in a low rate while you still can.

      • ClutchDude says:

        Good point. My insurance company will allow me to continue coverage when I leave. The downside is that I’ll need to pick up the employer’s contributions, which is to be expected.

        Double check before you decide.

  13. Dennis says:

    To quote my tax professor, “Buy term, and invest the difference.”

    http://en.wikipedia.org/wiki/Buy_term_and_invest_the_difference

    • treimel says:

      But the reality is, most people don’t invest the difference. Whole has the advantage *and* the disadvantage of being a forced savings vehicle.

  14. Decubitus says:

    FTA: “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.”

    This makes no sense. Life insurance benefits are not taxable when paid out in amount of the life insurance death benefit payable at death (ie, $50,000 benefit paid out in a lump sum of $50,000 vs more than $50,000 because it was paid in installments with interest). This is true for both term and permanent life insurance. Therefore taxation is no reason to choose permanent over term insurance.

    Once you determine the amount you need, regardless if it is for estate planning or funeral or whatever, you can buy that amount as term insurance and save on premiums. If someone can explain to me how permanent insurance benefit money is any different than term benefit money, by all means do so.

    • gvf says:

      Just like everything in this world, things are more complicated than yes/no when you get into the details.

      For advanced estate planning, permanent insurance can have a very useful purpose (granted most people do not need to worry about this).

      However, permanent insurance does have a place when setting up second-to-die policies for estate tax purposes. Yes, insurance is not taxed by the company, however, it is included in a decedents estate for ESTATE tax purposes (again, not a major concern for most people). Using permanent insurance inside of an ILIT can be an effective way to minimize tax burdens.

      And then there is the issue with permanence. True, term is cheap; but permanent insurance is permanent (and is building a cash value). Not that I advocate using insurance as a savings account, but for high income earning people, it does have a place as a piece of their over-all portfolio.

      As for commissions; have you ever wondered what your health agent gets (even if you buy it online)? Or your auto-policy agent (again, even if you buy it online)? I wish up-front commissions would be more level, but do me a favor and bitch to your representative (I already have) to change that.

      • Decubitus says:

        @gvf, @morgasco – Thanks for the explanation. I guess I was stuck in thinking of life insurance as “income replacement” while I still have obligations (mortgage, family, etc) versus using it as part of an estate planning strategy.

    • morgasco says:

      “Once you determine the amount you need, regardless if it is for estate planning or funeral or whatever, you can buy that amount as term insurance and save on premiums. If someone can explain to me how permanent insurance benefit money is any different than term benefit money, by all means do so.”

      Most of the time when you’re 60, 70, 80 and getting around to doing your estate planning you can’t get term policies that will cover you because of age and health condition you’re in at the time, leaving the only way to do the planning to permanent policies such as whole life, survivorship life policy, etc.

  15. barb95 says:

    Just don’t tell anyone you are taking out a life insurance policy. You don’t want to end up on an episode of Law & Order with a non-speaking role.

    • tbax929 says:

      It’s okay to say you have life insurance. Just don’t tell the person who’d benefit that they’re listed on your policy.

  16. toddkravos says:

    My take on life insurance is:

    I pay the company to bet I am NOT going to die.
    The company bets I am going to die.
    I know I am going to die, so the bet isn’t worth it

    Neither are the premiums.

    Then again, I do not have kids, spouse or other things that would warrant the need for life insurance.

    My funeral costs are handled by a different source.

    • Scoobatz says:

      Actually, you’re right. If no one depends on you, there’s no reason to have life insurance. Once you have a spouse or kids, it’s a whole different story.

      • coffeeculture says:

        Exactly. I mean, take care of it one way or another. Some people save a ton of money up and put it in the bank, most people buy insurance because they cannot sock away the cost of a mortgage + enough income to raise kids.

        No one said you had to buy insurance to be responsible…it’s just the cheapest/most practical way to protect.

        • RandomHookup says:

          And you don’t necessarily need to cover the whole mortgage — it really depends upon the circumstances of those left behind.

    • treimel says:

      Life insurance isn’t for the insured’s life, of course–it’s for the lives that depend on that life.

    • tbax929 says:

      If your employer provides it for you at no cost, there’s no reason not to have it. If you’d have to pay extra for it and don’t have dependents, then your logic makes sense.

      I want my family to be able to bury me and pay anything I owe. So a couple of times my salary is sufficient to do those things.

  17. Evil_Otto would rather pay taxes than make someone else rich says:

    I’ve been scuba diving below 75 feet ONCE. It apparently is enough, just that one time, to double my premiums were I to choose life insurance bought independently (instead of through my employer.)

    74 feet? No problem! 75? YOU PAY NOW!

    • morgasco says:

      I’ve never seen that a one time scuba expedition would cause them to rate the policy like that, have you tried contacting the insurer to explain to them that you don’t scuba on a regular/at all basis and to amend the policy/adjust premiums to reflect that?

  18. pmc1445 says:

    There are two generally accepted methods for calculating how much insurance you need, the Human Life Value (HLV) approach and the Financial Needs Approach. (There is a third called Capital Retention Approach, but most planners would tell you it is excessively conservative).

    The HLV approach is easiest to calculate. You figure out what the individual you are buying insurance for’s contribution to the family’s income is less their costs (food, clothes, etc…). In the case of a stay-at-home parent you calculate how much it would cost to hire a nanny to take care of the kids and cover other needs. Let’s call this “X.”

    Once you settle on that figure, you decide what returns you think you can achieve, net of taxes, and on average, by investing the proceeds of the insurance policy (based largely on how aggressive you would be comfortable being). Let’s call that “%.”

    Finally, you need to decide how long the surviving spouse would need to be supported by the insurance payout, say until the kids get out of college. Let’s call that “Y.”

    You can now do a time-value of money calculation to decide how much insurance you should carry. In Excel you’d type in “=PV(%,Y,-X,0)”. (The zero represents the future value at the end of twenty years, as you want the balance to be zero since support is no longer needed). For example, let’s say you thought you could achieve a 5% rate of return, thought you’d need the money to provide for a surviving spouse for 20 years, and that you’d need $100,000 a year. You’d enter “=PV(.05,20,-100000,0) and get a result of $1,246,221.03.

    After that, you can add in other costs as you wish, like a lump sum to pay off the mortgage, funeral costs, an “adjustment period” where the surviving spouse would be unable to work and would need extra support, etc… This gives you a good figure to work with.

    At the amount most couples with children need, it is fairly expensive and Term tends to be the best solution. Whole life is good if you buy it in your early to mid twenties or if you have a large estate you’ll need to pay taxes on for you heirs, but is often sold unnecessarily…

  19. threlkelded says:

    Speaking as a person who is about to inherit life insurance money, I have to say I think it’s far smarter than investments.

    Investments are part of the estate, and hence can be used to pay off lingering debts. In my case, the life insurance goes to me, the beneficiary, meaning it was never part of the estate, and I get to keep all of it that the IRS doesn’t take.

    Of course, I’m sure it’s different in every situation.

  20. JohnAllison says:

    Life insurance is a very powerful estate planning tool. The purchaser can buy life insurance that could eat up their entire savings so that when they die the beneficiaries receive a non-probate, non-taxed large sum of money. Now that rich person, for the price of the policy, generally a much smaller percentage than the IRS, is avoiding estate tax that plebeians still must pay!

    Life insurance is also good to mitigate the risk of a death having an adverse effect on ones family.