10 Common Mistakes in Purchasing and Owning Life Insurance

Transcript of Podcast Episode 200

Hello this is Bill Rainaldi, with another edition of Security Mutual’s SML Planning Minute. In today’s episode, Our 200^th episode! 10 common mistakes in purchasing and owning life insurance.

 If you’ve listened to this program before, you probably know how we feel about life insurance.  For most people, it is – or should be – one of their most important financial tools.   Having life insurance, however, is not enough.  You need to get the details right.  A recent article on the website My Federal Retirement – a popular blog for federal employees–outlined what they see as the 10 biggest mistakes people make with their life insurance. 

Here they are in order.

Mistake #1: Naming your estate as the beneficiary

Naming your estate as beneficiary is easy and is sometimes the default choice.  But doing so will cause the life insurance proceeds to be subject to probate. Perhaps more importantly, it can end up exposing the death benefit to the claims of creditors.

Mistake #2: Failing to name a contingent beneficiary

What happens if your beneficiary dies before you do?  The proceeds then go to your estate, whether you wanted that or not.  And it brings in the potential problems we just listed. The solution: name one or more contingent beneficiaries.  That way, the new beneficiary will automatically move up if the originally named beneficiary dies.  Another possible—and in some ways better–solution may be to use a life insurance trust as the beneficiary.

Mistake #3: Failing to monitor the policy

Circumstances change, and your policy needs to change when they do.  What happens, for example, if you get divorced?  What happens if there are new children after the policy is issued?  What happens if you miss a premium payment?  Like anything else, a life insurance policy requires monitoring.  You can’t simply buy it and forget about it.

Mistake #4: Buying the wrong type of policy

How long are you going to need this policy?  How important is cash value?  How about the guarantees or lack thereof? A knowledgeable life insurance professional can help determine not only the type of coverage you need, but the right amount.

Mistake #5: Not getting enough coverage

One of the main causes of financial stress for families in 2022 is a level of inflation  we haven’t seen in 40 years. Many people have to face the fact that what seemed like sufficient coverage 10 years ago is inadequate today.  People need to ask themselves: will your surviving family members have sufficient funds to pay the debts and expenses  required, not just now, but in the future? Many life insurers offer online calculators to help you estimate your life insurance needs. These calculators consider income, debts, living expenses, education costs, extraordinary expenses and other financial commitments to estimate the amount of protection you need.

Mistake #6: Naming a minor or grandchild as a beneficiary

This is a no-no, but it happens more than most people realize.  Your children may indeed be the ones you are trying to protect, but no insurance company will pay large amounts of money to minor children or grandchildren.  A custodian or guardian would need to be appointed first.  It may be better and less expensive to set up a trust in advance on the children’s behalf and name the trust as beneficiary.  This will avoid several legal restrictions that exist for outright distributions to minor children or grandchildren.

Mistake #7: Owning the life insurance yourself

As we’ve discussed many times on this program, most recently in episode 195, estate tax laws are likely to change in the future.  While most people don’t have to worry about today’s estate taxes, that could all change.  And owning insurance on your life could have devastating tax consequences if it does.  But the policy can’t be included in your estate if you don’t actually own it or have any rights to it. This is true even if you make a gift of the money needed to pay the premiums.

Mistake #8: For Federal employees, not understanding the costs involved with the Federal Employees Group Life Insurance, or “FEGLI” program

FEGLI is a popular insurance program for federal employees.  Premiums come directly out of the employee’s paycheck.  The cost is generally reasonable while the employee is still working, but goes up dramatically when he or she retires.  In fact, the FEGLI “Basic Insurance” program will be subject to a 700 to 800 percent premium increase if they wish to keep that coverage once they retire from their federal job.  It might make sense to look at your other options while you are still working.

Similarly, employees working in the private sector who have group life insurance benefits can expect to see large premium increases to convert and continue life insurance coverage after retirement.

Mistake #9: Forgetting that term insurance only has a limited time of coverage

Term insurance, including employer-sponsored group insurance, offers a limited period of coverage.  The older you get, the more it costs. 

Many people fail to grasp the difference between “cheap” and “inexpensive.”  For example, term insurance will always require a lower initial dollar outlay than whole life, but the vast majority of term policies end up expiring before the death benefit is paid.  The key is to keep your lifetime goals and objectives in mind when making the decision.  If your life insurance policy fails to provide protection for the time needed, it is in fact the most expensive option, regardless of how cheap it at first appears.

Mistake #10: Failing to understand the limits of “pension maximization.”

Pension “maximization” is a concept that became popular a few decades ago, particularly with federal employees.  This is because the Federal Employees Retirement System, or “FERS,” offers a survivor annuity.  Basically, when the employee retires, they can choose between a retirement annuity benefit for themself only; or choose a lower amount for lives of both they and their spouse.

Pension maximization is where the employee chooses the higher single life amount, then uses some of the difference in income to buy life insurance to protect the spouse.  But there are issues with this approach.  For one thing, the retiring employee has to be insurable.  For another, he or she needs to buy enough insurance to meet the income needs of the surviving spouse. Finally, if all of the additional after-tax income derived from electing the higher single life amount gets spent on life insurance premiums, you have accomplished little, if anything.

Life insurance is a critical tool for almost anyone, but sometimes it can get complicated.  This list is far from exclusive, and you need to plan carefully.  Each person’s situation is unique. Your Security Mutual Life Insurance Advisor can help you to get the process started.  Your advisor will assemble your team and coordinate with your attorney and tax professional to review your situation and to determine the insurance plan appropriate for you and your family. 

This podcast is brought to you by Security Mutual Life Insurance Company of New York, The Company That Cares®. The content provided is intended for educational and informational purposes only. Information is provided in good faith. However, the Company makes no representation or warranty of any kind regarding the accuracy, reliability, or completeness of the information. 

 The information presented is designed to provide general information regarding the subject matter covered. It is not to serve as legal, tax or other financial advice related to individual situations, because each individual’s legal, tax and financial situation is different. Specific advice needs to be tailored to your situation. Therefore, please consult with your own attorney, tax professional and/or other advisors regarding your specific situation.

 To help reach your goals, you need a skilled professional by your side. Contact your local Security Mutual life insurance advisor today. As part of the planning process, he or she will coordinate with your other advisors as needed to help you achieve your financial goals and objectives. For more information, visit us at SMLNY.com/SMLPodcast. If you’ve enjoyed this podcast, tell your friends about it. And be sure to give us a five-star review. And check us out on LinkedIn, YouTube and Twitter. Thanks for listening, and we’ll talk to you next time.

The applicability of any strategy discussed is dependent upon the particular facts and circumstances. Results may vary, and products and services discussed may not be appropriate for all situations. Each person’s needs, objectives and financial circumstances are different, and must be reviewed and analyzed independently. We encourage individuals to seek personalized advice from a qualified Security Mutual life insurance advisor regarding their personal needs, objectives, and financial circumstances. Insurance products are issued by Security Mutual Life Insurance Company of New York, Binghamton, New York. Product availability and features may vary by state.