Another important building block in your financial plan is insurance. Insurance is a way of managing risks we can't prevent.
Developing Your Insurance Plan
Insurance should be used to protect you and your loved ones against a major disruption in your earning power or damage to property. It is an essential part of your financial plan and provides much needed peace of mind.
Insurance should never be used as a means of saving or investing. When you buy auto or homeowner's insurance, you don't buy a savings plan to go with it, do you?
Many life insurance programs include some sort of saving or investment element. Insurance companies invest your money very conservatively; therefore the rate of return may only keep up with inflation at best.
The return on your investment dollar will be higher with many other investments that are just as secure. Additionally, if you make investments inside a life insurance policy, there are a number of hidden fees and restrictions.
There are essentially three types of life insurance - term, whole-life and universal life.
With Term Insurance you pay a specific premium to obtain protection for a specific time period, often one year but for as long as 20 years.
Whole-life insurance is a policy where the face amount and premiums remain the same for the life of the policyholder. In order to have a level premium, even though there is an increasing likelihood of death, the actual payment of benefits includes a graduated schedule of cash values, in addition to the face value of the policy.
Whole-life includes this concept of "forced savings" where some part of the premium is deposited into essentially a savings account. If you have a need for this money before death, the only way to get the cash value is to 1) cancel the policy (with additional fees) or 2) take out a policy loan. The additional problem with this traditional insurance policy is the rate of return on the cash values is typically very low.
A third type of life insurance policy is Universal Life. Insurance companies invented universal life, sometimes called variable universal life as a way to make money out of a complicated product. This type of policy has three parts: Protection, Savings, and Expenses.
The Protection part of a universal life policy is the death benefit. To keep the premiums level, the death benefit lower in the first several years, increases during your peak earning years and as you approach retirement decreases. This decrease in the death benefit is offset by the increases in the savings part of the policy, such that when combined together pays an amount roughly equal to face value of a policy.
Life insurance is not the only type of insurance you may need. Buying several policies from the same agent can frequently result in several discounts to the overall premiums. Other types of insurance you may need could include: renter's insurance, homeowner's insurance, disability insurance, auto insurance and health insurance. Just be sure to pick an agent that you like and you feel you can trust.
Managing Your Insurance Policies
Here are several principles of life insurance policy management to keep in mind so you never pay more for insurance than you need to, these include:
Keep life insurance separate from other types of insurance (separate policies).
Don’t add on features such as double indemnity or accidental death.
Never buy insurance with dividends; it will cost your more than it will pay.
There are several types of insurance you should never buy. These include: deposit term, endowments, gimmick policies with riders, and unsolicited policies that come in the mail. Remember you are paying for the advertising cost and many of these policies may have lower ratings.
Deal with a reputable agent. It pays to shop around. When shopping for a family insurance agent, look for an agent who takes what they do seriously. Check for referrals, and credentials.
Term insurance is almost always less expensive.
Invest outside of your insurance policy. That way you can control the return, risks and how you invest (More on investing in later chapters).
Who Needs Life Insurance?
Most financial experts agree on the following life insurance guidelines:
If you are single and do not have dependents, don't buy life insurance or only buy term insurance with small face value. You may be able to get this sort of insurance as part of an employer's benefit package. You need enough to pay off debts and cover final expenses.
If you are married and have no dependents, you need less insurance and again this may be available through your employer. A permanent life insurance policy becomes more important as you start a family.
Reducing the Cost of Insurance
There are several things that you can do to reduce the cost of the various types of insurance coverage you may need. Here are some suggestions:
Check to make sure you are not excessively covered, or that you are not insuring for things that are no longer appropriate. For example, when kids leave home, remember to drop them from your auto policy and health care plans.
Have your employer pick up more coverage. The trend over the last several years is for employers to pass the increased costs of medical on to employee with larger premium payments. See if you can talk to your employer about any options you have to select more medical coverage for less life insurance or some other form of self-electing coverage.
Avoid duplicate coverage. If you are married and you both work, make sure only one of you are picking up the costs of insurance.
Compare the cost of your life insurance to comparable term coverage. Sometimes shopping online can save you money, just be sure to deal with an established company.
Coordinate individual coverage you may have with group plans. For example, if you have group life, can you carry a smaller term life insurance policy and still get the coverage that you need.
Increase your deductibles on things like homeowners or auto insurance. With a good savings plan you can afford to self-cover some of the risks yourself.
Insurance is an important building block of your financial freedom. Adequate coverage takes precedence over spending your money on investments or tax shelters, remember we are building a financial home and it needs a strong foundation before venturing out into the world of investments.