Are You Covered? Hidden Gaps in Life Insurance That Could Cost Your Family

18:35Sean Pyles:We're back and answering your money questions to help you make smarter financial decisions. This episode's question comes from a listener who prefers to stay anonymous. My mom passed in May. Soon after she passed, we learned that she didn't have very much life insurance, which is making things hard for my dad. To prepare ourselves and our son for the future, my husband and I are trying to determine how much life insurance we need and if we should focus on term or whole life. We are both healthy and in our late 30s. Additionally, if we create a trust, do we make the beneficiary the trust or our spouse slash son?

19:07To help us answer this anonymous listener's question, on this episode of the podcast, we are joined by insurance nerd Kaz Wida. Hey, Kaz. Hello.

19:17Sean Pyles:Hey, Kaz. Welcome to Smart Money. Thank you. So the world of life insurance, as you know, someone who's written in this space for a while, can be really confusing and there's a lot of vocabulary to pin down. So let's start by laying out some of these definitions. There are a lot of different kinds of life insurance, many of which aren't a great idea for most folks. But the two most common are term life insurance and whole life insurance, which is a form of permanent life insurance. So can you give us a quick explanation of each type? Before we dive into that, I'm so glad you got this question because unfortunately, a lot of people don't think about life insurance until it's sort of too late.

19:53So sad we have someone posing as a cautionary tale here of what can happen when you're underinsured. So the two basic forms of life insurance, as you said, these two basic buckets that life insurance fall into, term life insurance and permanent life insurance. And they are pretty much exactly what they sound like. Term life insurance is life insurance that extends for a certain term or time period. So 10, 20, sometimes 30 years, the insurer will pay out a death benefit to your beneficiaries if you die within the term of the policy. Permanent life insurance is, again, sort of what it sounds like.

20:33You are paying for permanent life insurance coverage. But along with that, of course, comes a caveat, which is it can be much more expensive. than term life insurance. Well, Cass, can you explain when one of these options might be better than the others? What kind of factors should people be considering when they're weighing their options? So at NerdWallet, we sort of tell everyone, hey, for most people, term life insurance is going to be the way to go. And there's a couple of reasons for that. The first is that term life insurance is, of course, really affordable, and that's going to fit most people's budgets, depending on where they're at.

21:11And it's especially affordable if you're looking at buying life insurance when you're young and you're healthy. So as you age, of course, life insurance gets more expensive because it gets more risky for the insurer. The other reason we say term life insurance is usually going to work best for most people is that's sort of the point of life insurance is to insure you for a time period when if your family were to lose your income, it would be a financial burden for them. And that's usually a set number of years, right, when you're in your prime working years. That is not to say, though, that permanent life insurance doesn't have its uses.

21:48So permanent life insurance can be a good idea in a few scenarios for people, usually folks who are looking to maybe shelter an estate, a large estate from taxes, or perhaps looking to diversify retirement income as older adults. There are even some scenarios where permanent life insurance can be used. Some smaller policies get used just for final expenses, burial costs. And then some folks like the lifelong coverage because they're looking at providing for perhaps a child or another dependent with disabilities. And so they want that insurance policy to really last well into adulthood for that child.

22:26Sean Pyles:Whenever we talk about life insurance and smart money, and I have the same house view as you, Kaz, that most folks term is the best, we always hear from someone who says whole is better. And in fact, very few term policies pay out, which is true. And that's actually part of why term is so much more affordable, because it's actually pretty unlikely that you're going to have to pay out that policy, which I'll say is a good thing, because that means that you didn't die during the term of your policy. Another thing I want to get into is, like I mentioned earlier, there are a lot of kind of eccentric forms of life insurance, things like universal index life insurance and variable universal life insurance.

23:07Sean Pyles:And these are actually kind of hybrids of investment accounts and life insurance products. This idea of having investments with your life insurance can be really appealing to people because they think it's some kind of secret financial product. But I'm really, really wary of them. So Kaz, can you talk a little bit more about these accounts and what their use case might be? So like you, I'm wary of any sort of product, and this includes insurance products that have a lot of complicated sounding words in the title. You know, if I don't know what they mean, I want to make sure I really understand what I'm getting.

23:40And insurance works this way, too. Before we talk about those specific products, we probably want to talk about what's so attractive about permanent life insurance for folks. And part of this is a feature that's built in to permanent life insurance, and that is cash value. So when you pay your premium for your life insurance, part of it goes towards insuring you, the cost of the policy, those sorts of things. But the other part of your premium goes towards building cash value. Depending on the type of permanent life insurance you have, it may grow quite slowly. It may take several years for you to build up any cash value that you could potentially use in any way.

24:20But eventually, this pool of cash money that you have been building through your life insurance is supposed to be something you can borrow against later, perhaps used to pay the premiums on the policy, so it's just a sort of self-sufficient, or even withdraw or surrender later on if that were to become a need. So permanent life insurance is attractive for that reason, and it serves a purpose for some folks because of the cash value. Now, that being said, you referred specifically to indexed universal life insurance, I believe. And part of the problem with those particular types of life insurance is that there is more risk.

24:58So index specifically, the cash value grows according to stock indexes. So your pool of money might grow quite quickly and it might be really encouraging when the stock market is up. When it goes down, maybe not so much. And you do face a situation in which if you don't keep a close eye on that policy and on your pool of money, your cash value, your policy could become underfunded and you could risk losing your coverage if you didn't pay the difference. So there's risk there, certainly with some of those permanent life insurance policies, and they're really for people who are comfortable with that risk.

25:34Sean Pyles:And additionally, the fees on these accounts tend to be higher than the fee you'd pay for a taxable brokerage account too. So I like having different products for distinct purposes. I'm investing through my taxable brokerage account. I have my life insurance elsewhere. I don't really care to intermingle the two because of the fees and the mixed intention behind them. So that's just me. So for people who are looking at it maybe as a potential long-term investment vehicle, how would you say they weigh whether they should get a whole-term life insurance policy and use that or just invest in the stock market?

26:08Yeah, I mean, I think as Sean pointed out, for the most part, using life insurance as an investment vehicle isn't necessarily going to work out the way you think it's going to work out. So normally it's an avenue for folks who have sort of exhausted all the other avenues for investment and, you know, sort of those tax advantaged accounts. So this is a place you could put some money if you didn't have another place to put it and you wanted it to grow in a certain way.

26:35Sean Pyles:Yeah, if you're really trying to hide your money from the IRS and you've maxed out your 401k and all other options, maybe you can look into these next. And I just want to point, it's legal. Yeah, I was going to say, I don't think we're advocating that, but yes. No. No, yeah. All right, let's pivot a little and talk about how much life insurance one might need. This is a common question I hear people ask. Our listener said that their mother didn't have a lot, and this is making things hard for their father. There are a few different ways that folks can determine how much life insurance they might need.

27:07Can you lay those out for us, Kaz? Sure. And I have a lot of compassion for this scenario because this is really common, unfortunately. you know, you have one parent and maybe they're more traditionally employed and they have group life insurance or something through work. And then the other parent does not, either because they're a freelancer, which is pretty common now, a contractor, maybe a stay-at-home parent. So this is a really common scenario. Trying to figure out how much life insurance you need can kind of be a difficult exercise depending upon how you come at it and what your circumstances are.

27:42So we can sort of look at those methods. But before we do that, let me just say there's a really simple way to think about life insurance, which is if someone in your family were to die and that the death of that person would cause a financial burden on the survivors, that person should have a life insurance policy, no matter who they are. So that's a good way to think about, do I need life insurance? When you're thinking about how much you need. There's basically three methods that you hear about a lot from life insurance agents and in the industry. The first is pretty simple. It's take your annual salary, multiply by 10.

28:19So just put a zero on the end of it. And that's how much life insurance you should have. I would say this method is not really ideal because as you can imagine, it fails to account for a lot of different things that are pretty common for most people, having kids, having a mortgage, maybe even having student loans, things like that. So it could be enough life insurance for you, depending on your situation. The second method is to do that simple method, but then you add$100 ,000 per child. And the idea behind that is I want to capture educational expenses, college, private school, all the things that you would pay for as a parent if you were there to be able to support those things.

28:59And that's certainly a little bit better than our first method if you're a parent. The third method, which is something that we discuss a lot at Nerd Wallet on the insurance team and that we encourage folks to think about, is called DIME. And I guess anytime you need an acronym to remember something, it's a little more complicated, so bear with me. The D in DIME is for debt. So you want to take a look at what are your debts, what's your mortgage, car loans, student loans, all of those types of things, hiding in corners, credit card balances, put that all into the balance of the life insurance coverage that you would need.

29:33The I in dime is for income. So what we were talking about with the methods before, you want to multiply your annual salary times some number of years. I'm not saying it's 10. It's probably not if you're younger, hopefully. It might be 20. It might be even more than that. The M in dime is for mortgage. And this is for folks who own a house. And that's probably a pretty big ticket debt that you want to make sure you capture in some way if you didn't capture it under debts. And then the last part of dime is E for education, which we talked about before. You want to add some money for educational expenses for any kids that you have that you would want to support that for them.

30:16And so this method obviously is a little more thorough than the other methods. And if you're like, I don't want to do that math, it's OK. You can come over to NerdWallet. We have some calculators that do it for you on the website. One of them is called How Much Insurance Do I Need? You can just plug your stuff in and it'll spit you out a number.

30:33Sean Pyles:And we'll include a link to that calculator in our show notes. One thing I want to go back to, Kaz, is the idea of being a financial burden, because I think a lot of people might not understand that these come in many forms. If someone is working in the house but not bringing in an income, that's a form of labor, even though they aren't earning a salary. So if the parent who is the primary home manager, kid caretaker passes, that can create a huge financial burden in the household because you have to think about the child care that you would need, among other things, too. So I would encourage people to really think hard about this idea of financial burden and whether they do need life insurance or not.

31:11This is something that I just recently wrote about, actually. A lot of times stay-at-home parents are not part of these life insurance conversations, and they really should be because there's a definite value there that is not represented in some life insurance approaches. I love the dime example that you gave in terms of how to calculate your net worth. But I had a question about where your existing net worth fits into that. So let's say you have, I don't know,$100 ,000 or$200 ,000 already in your 401k. Where does that factor into how much life insurance that you need? So what we tell people about 401ks and things like that is those are not liquid assets.

31:45So that's not something you're going to be able to tap into quickly. That's going to get tied up in all sorts of other legal proceedings. And what you want to do if you're looking for, is there something that I have already on the table that I can pass along to my beneficiaries that means I don't need as much life insurance coverage? You want to just look at straightforward savings. What's in your savings account? What's in your money market? What can you liquidate? That you can subtract from your bottom line. So if you were doing the die method and then you wanted to subtract because you have, you know, a pool of money just sitting there, you could subtract that if it was in a liquid form and easily accessible to you.

32:25All right. So the price of life insurance can vary pretty widely. How much should our listener expect to pay for their life insurance? I can get you in the right ballpark. Hard to know without having a lot of details about your health, which your insurer is going to want to know. For sure. So be aware of that. But I think you'll be surprised how affordable, especially term life insurance is if you're young and healthy. This is pretty shocking for some folks who think of life insurance as something that's more expensive. So if you're looking at a 20-year term policy, and that's the average term policy that people buy.

32:59That's the most frequent term folks purchase. About$500 ,000 is what most folks are buying these days. If you're looking at that for a 40-year-old and you break it down by a per month cost, it's going to cost you about$26 a month. And I'll put some caveats around that, which is you can't be a smoker. So that's for a non-smoker and you have to be in good health, excellent health, but fairly affordable cost, especially when you break it down in a per month.

33:27Sean Pyles:That's about how much my HBO Max subscription costs. I know, I'm in the boat with you. I got Netflix. Anyway, so I, like what you said, I did go from whole life to term And I went from paying around$200 a month to around that$26. So it's a significant amount in savings there. Our listener mentioned that they and their partner are both in their 30s and they're healthy. So how might that factor into the equation? Knowing those details helps you sort of filter out some of the noise there. At 30, life insurance, especially term life insurance, is super affordable. So you're talking about the same sort of policy, 20-year term,$500 ,000 in coverage.

34:06you're going to look at about$200 annually, depending on the same factors. You can't be a smoker and you've got to be in pretty good health, but that works out to be, you know, under$20 a month, which I think most families would find fairly affordable and certainly better to leave behind a life insurance payout than your HBO subscriptions.

34:27Sean Pyles:That might be up for debate, depending on who's getting access to it. I know, right? Fair. One thing I'm thinking about is whether our listener has life insurance through their employer through a group term life policy, a lot of folks can get up to$50 ,000 in coverage for free through their employers if this type of benefit is offered. And people can also usually pay for additional coverage if that$50 ,000 isn't enough for them. Also, some employers let you even convert these policies to your own when you leave that employer. And that can be a huge benefit letting you take this coverage with you.

35:02Sean Pyles:So, So, Kaz, how do you think our listeners should consider this type of group term life coverage as it compares to other options? Yeah, I mean, I think a lot of people have group life insurance and some of us don't even know it. We click a box when we go through the benefits and then sort of forget about it. But there are a lot of folks covered through their employer. But these are rather small policies in terms of life insurance. So at NerdWallet, what we say to folks is, yes, absolutely great that you have group life insurance. Life insurance would be a better bet getting an individual term policy on top of whatever group life insurance you have so that you have some additional coverage.

35:41You can buy supplemental insurance sometimes through your employer, but typically some of the rates might be a little bit better if you go out and shop for an individual policy. So we just encourage people, great that you have group life insurance, probably need more than whatever group life insurance you have. So take a look at that coverage and then make sure you have enough for your situation.

36:03Sean Pyles:That makes sense. Something I think people should also consider is that with group term life insurance, people generally don't need to go through a health assessment, which is a common part of getting other life insurance policies. So for people who might have a chronic health condition, these workplace plans can be really helpful and can be a pretty easy way to get much more affordable coverage. But again, it might not be as much as you would actually need in general. So explore all of your options here. And there are some insurers who do specialize in specific kinds of coverage for people with ZOM pre-existing conditions.

36:36So doing your research can really pay off. And we try to help folks do that at NerdWallet.

36:41Sean Pyles:Well, now let's get to the last part of our listener's question about who to designate the beneficiary of their trust, their spouse and their son, or the trust itself. Now, Kaz Elizabeth, correct me if I'm wrong here, but I'm not aware of a scenario where the trust can be the beneficiary of itself. So I think the money would just go right back where it already is. So assuming the goal of this trust is to distribute assets to the listener's family after their death, our listener would likely want to designate their son and or their spouse as the beneficiary or beneficiaries because you can have multiple.

37:12Sean Pyles:And there are a lot of different ways to structure trusts. So what I would recommend our listener do is consult with an estate attorney who can answer all of their questions and ensure the trust is set up exactly how they want it, because this can get so complicated. Elizabeth, I know that you have a trust for your son. So can you talk a little bit about how yours is set up and what the process was like to establish it? My son is a minor. He's only seven years old at the moment. So heavens forbid I was raptured. He wouldn't legally be allowed to manage the money on his own. So what I had to do is, and I think this was actually the hardest part, think about beneficiaries for my trust and also guardians that I want to help manage the money for him until he's of legal age.

37:53And as a single mom who lives far away from family, that was a difficult process to think through who I trusted to manage the funds for him and also who I trusted to be his guardian. I did use Rocket Lawyer for the whole process though because I do not have a complicated estate. Yes, that means don't email me for money because I ain't got none for you. So if you don't have a complex estate, you can use an online platform like Rocket Lawyer to go through the process. But yeah, that's essentially what I did. So I have multiple beneficiaries in case one passes away, so another one can take over. And I also did it in a way where I broke up the responsibilities for distributing the assets as well.

38:27So one person might be responsible for daily expenses, another for educational expenses. And the thing I love about the trust as well is I was able to layer when he receives the money. So it's going to be in different batches at different life stages versus all at once. Yeah.

38:42Sean Pyles:And using a tool like Rocket Lawyer can be super helpful for getting in the door. But I would recommend anyone who uses a tool like that to consult with an attorney too, just to make sure that all the I's are dotted and T's are crossed, because these documents can be really complicated and you don't want something to go awry after you pass because something in the paperwork wasn't exactly how it needed to be. And that was, you know, maybe on the fault of Rocket Lawyer for not having their stuff properly set up. Oh, sorry. I did forget to add that I had an estate attorney look over the trust as well to make sure everything looks okay.

39:12So thank you for that tip, Sean.

39:13Sean Pyles:Of course. Okay. Well, Kaz, any final words of wisdom that you'd like to leave our listeners with around shopping for life insurance or maybe the trust question, anything that we've talked about today? One of the things that we often advise people is not only to, you know, update your coverage, make sure you have enough coverage, but also remember to update your beneficiaries. This too often happens where there are life insurance policies, you've got everything in place. And unfortunately, you did not update your beneficiaries and it sort of complicates things. So make sure that you periodically just check in every year or so.

39:49Make sure that all of that, all your T's, you know, are crossed and your I's dotted because this is something that is going to end up causing some headaches in the future if it's not.

40:00Sean Pyles:Well, Kaz, thank you so much for coming on and sharing your insights today. Yeah, my pleasure. Thanks so much for having me. And that's all we have for this episode. Remember, listener, that we're here to answer your money questions. So turn to the nerds and call or text us your questions at 901-730-6373. That's 901-730-N-E-R-D. You can also email us at podcast at nerdwallet.com. Join us next time to hear a lightning round about different financial topics from housing to investing. Follow Smart Money on your favorite podcast app that includes Spotify, Apple Podcasts, and iHeartRadio to automatically download new episodes.

40:34Sean Pyles:Here's our brief disclaimer. We are not your financial or investment advisors. This nerdy info is provided for general educational and entertainment purposes and may not apply to your specific circumstances. This episode is produced by Tess Vigland, Hilary Georgie helped with editing, Nick Korsumi mixed our audio, and a big thank you to NerdWallet's editors for all of their help. And with that said, until next time, turn to the nerds.

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