Choosing a life insurance policy

Which type:

Life insurance is a highly competitive business, in which the salesforce depends almost entirely on commissions.

Insurance companies pay fat commissions for selling whole life policies; perhaps 80% of your first year's premium goes to the agent. Commissions for selling term-life policies amount to roughly the same percentage of first-year premiums. But since whole-life premiums are much higher than premiums for term-life policies with the same death benefit -- they can be five to ten times more -- agents make much more money selling a whole-life policy than they do selling a term policy.

It's no wonder, then, that agents push whole-life policies as if their livelihoods depend on it. But the fact is the vast majority of those who need insurance should buy term.

The main reason is cost. Term policies are cheap for relatively young people who are in good health.

Agents will argue that whole-life policies are superior because you can keep them the rest of your life and build up cash in them tax-free, which can then be borrowed.

That's true, but they don't tell you about the high fees and commissions built into whole life as well as surrender charges (if you want to cancel the policy) that often leave you with little or no cash value five and even 10 or 15 years after you take out the policy.

The point of a tax-free buildup of cash just isn't that powerful anymore, given the proliferation of IRAs, 401(k)s, and other tax-advantaged savings vehicles that have tiny commissions, much higher yields and complete portability.

So stick with term, and do your investing elsewhere.

One more thing: Steer clear of so-called mortgage insurance policies, which pay off the balance on your mortgage if you die. The problem is that you are paying for a steadily declining amount of coverage, as you pay down your mortgage. It's best to include the mortgage payments in your calculations when determining how much coverage you need.

How much:

Some financial planners say you need enough insurance to replace five to seven years of your salary. If you have young children or significant debt, you should bump up your coverage so you have enough to replace as much as 10 years of your salary, they say. Remember, the sole purpose of life insurance is to replace your income in case you die, so that your dependents can maintain their current lifestyle.

Will the surviving partner have child care expenses if one partner is out of the picture? Do you have other assets on which to draw? Will your children be out of the nest soon? These, and many other factors, influence the decision on how much coverage you need.

How long:

The secret to buying a policy with the right term is figuring out how long you need to be insured. Start by estimating when your children will be out on their own and no longer in need of your financial support. You may also want to cover your spouse for your lost income until what would be your normal retirement age.

Life insurance is not a substitute for a retirement plan. You want to plan so that you'll have enough to live on when you retire, and you won't have to keep paying insurance premiums.

There are exceptions, however. People who start families late in life, or who have complex estate-planning issues, may well have a need for life insurance beyond the customary retirement age.

When to buy:

The cheapest rates, known in the business as select or preferred, go to those who are in good health and who have a family history of good health. If you have a health condition, are grossly overweight, smoke or have a risky occupation, you may pay 50% more than preferred rates.

So there's a good case to be made for getting a policy early in life while you are still in good health. However, it doesn't make much sense to buy one until you have dependents.

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