How Much Is Your Life Worth? Life Insurance 101

Many people avoid buying life insurance, which is hardly surprising: they worry that it will be complicated or expensive, or that it will put them face-to-face with their own mortality (or an insurance agent; same idea).

As a result, many folks who need life insurance don’t have it, and plenty who do don’t actually need it or have the wrong kind. Mint.com has a simple, easy-to-use tool that can help you figure out whether you need life insurance, how much and what kind of policy works best for you. But life insurance is so complicated — and different people’s individual circumstances so varied, that no one tool can help answer all questions that you may have about it.

Below, you will find answers to some of the most common life insurance questions. Hopefully, those will help you further in determining what insurance you need–if any–and how to get it at a fair price.

Should I have life insurance?

You need life insurance if your death would cause a financial hardship for someone else. If that’s not the case, you don’t need life insurance, which is nothing to be ashamed of. Maybe you’re a maverick, boldly forging your own path—or just a college student, or single with no kids, or you’re retired and your loved ones are provided for or financially independent.

If you’re a sole breadwinner with multiple children, you’ll need a lot more insurance than a homemaker with an income-earning spouse and just one child. It’s all about the dependents. The homemaker probably still needs insurance, however, to cover the loss of the services they provide for free.

Okay, I need some life insurance. How much should I get?

More than you think. The most common rule of thumb is seven to ten times your annual salary. Even people whose surnames are not Trump or Warbucks routinely buy million-dollar policies.

There’s no getting around it: the big dollar figure on life insurance policies seems absurdly high. When a person dies unexpectedly, however, the money often needs to last many years, and may need to replace not only current income but future savings goals like college expenses.

“Let’s say you buy a million-dollar policy,” says Tony Steuer, author of Questions and Answers on Life Insurance. “Your beneficiary receives that amount of money and invests it. What type of return would they get on that principal? Even with a million dollars, at 4%, you’re talking $40,000 a year of income. When you look at it from that perspective, the larger amounts of coverage really aren’t out of line with what people need.”

That’s if you don’t want to touch the principal, of course. Assuming a higher rate of return or drawing down the principal means a higher rate of income replacement. But buying more insurance often adds only a few dollars to a premium, and it often takes families much longer than they expect to recover financially from a death. Yes, this is the sort of thing insurance agents are always saying, but it’s true. We’ll get to some of their more fanciful claims later.

Isn’t a million dollars worth of life insurance going to cost me, like, a million dollars?

“Term insurance is, relatively speaking, dirt cheap,” says Rob Fish, a Boston estate planning attorney. A young person (say, 35) in good health could buy a million-dollar 15-year term policy for under $30 a month.

“Fifteen-year term” means the insurance company will pay the beneficiary if you die within fifteen years of buying the policy. The company also won’t raise your premiums during that time, even if your health situation changes. You can buy longer or shorter terms, of course.

What if I’m not in perfect health? Can I still get life insurance?

Probably. “There are sixteen different health classes at most companies,” says Tyler Proffitt of Efinancial.com, an insurance broker. “The top 3% to 5% of Americans fit into Preferred Plus,” the top category. The next several categories down from there (maybe you’re a few pounds overweight or a close relative has heart disease) are still pretty good and won’t raise your premiums much.

But even people with chronic diseases can qualify for life insurance. Working with an agent who has experience with insuring people with your condition can help you get the best rate.

Googling the name of your condition plus “life insurance” can give you a sense of what insurance companies are offering. People with diabetes or heart disease, for example, routinely get coverage. “And many times, you’ll be surprised that the rates are much less than you thought they were going to be,” says Marvin Feldman, CEO of the LIFE Foundation, and insurance industry group.

People with health problems may also be able to get insurance through their employer, no questions asked.

Oh yeah, my job offers group life insurance. Should I just go with that?

It depends. “If someone’s in good health, they’re almost certainly going to do better in the individual marketplace,” says Steuer. Furthermore, most group insurance is limited to a small multiple of your salary, and the premiums go up over time.

If you’re young and have minimal insurance needs (maybe you want to carry a little insurance to cover funeral expenses) or have a health issue that would make you hard to insure otherwise, however, group insurance is great.

What if I smoke?

Quit. Smoking nearly quadruples your life insurance premiums. It’s also rumored to be kind of bad for you.

Where should I go to price life insurance?

Mint.com has its own life insurance wizard. You can get quotes from many different insurance companies in a matter of seconds and you don’t have to be a Mint.com member to use it.

You keep saying “term life” like there’s another kind. Is there another kind?

Yes, there’s permanent life.

That sounds so awesome. Sign me up.

Not so fast, Sparky. Permanent life (also known as a cash-value policy, Whole Life, or Universal Life) is an investment product fused with a life insurance policy. It works kind of like a mortgage: part of your premium goes to pay for the insurance portion and part builds up equity (“cash value”). The longer you hold the policy, the more cash value you build up, and you can keep the policy into your 90s, if you want, which you can’t do with term insurance.

You don’t sound too excited about this.

“I’m a big believer in term life insurance for the most part, since most people have temporary needs,” says Steuer. Permanent life has much higher premiums than term life; it’s complicated; and it produces relatively meager investment returns most of the time.

James Hunt analyzes life insurance for the Consumer Federation of America, and most of his clients come to ask whether they should stick with their cash-value policies. “I would say, generally speaking, more often than not I recommend a change,” he says, because often “the policies produce low or sometimes negative rates of return.”

Hunt often recommends the Universal Life products at TIAA-CREF, which have no commission or surrender fee, two common gotchas in these policies.

So, should anyone ever buy permanent life?

Yes. There are several situations where it makes sense.

First, “when somebody has a special-needs child, it makes sense, because that child will always be financially dependent,” says Steuer.

Second, permanent life insurance can be a valuable estate-planning tool. “Valuable estate-planning tool” is a euphemism for “helps you legally avoid the estate tax.” Of course, there’s no free lunch: in order to pull this off, you have to put your policy into a trust permanently controlled by someone else. “In most things in estate planning, the tension is between control and the tax benefit,” says Fish.

Finally, “I do have some people who really like the appeal of the forced savings,” says Steuer. The type of permanent life policy called Whole Life is especially well-suited to this goal.

Photo: alancleaver_2000