How to buy a life insurance policy

About 35 million U.S. households have no life insurance coverage, according to a study by LIMRA, an industry research group. And more than half of American households say they need more life insurance. But, like many financial products, life insurance policies can be complicated by various terms, riders and stipulations which make the purchase of even a straightforward policy tough. In fact, consumers are so confused about buying life insurance that many postpone a purchase or never buy at all.

In the event of a person’s death, a life insurance policy provides their spouse, family or named beneficiaries immediate money for funeral costs and other everyday living expenses. Life insurance is designed to replace the income generated by a wage-earner and to help cover things like mortgage payments, children’s college education and other major expenses over a lifetime. Here’s how to get started:

Determine how much coverage you need

Do the math. Figure out what your spouse and family would need financially if you weren’t around. Take into account your lost income and outstanding debts such as a mortgage and big bills like college tuition or medical expenses. There are numerous online calculators and worksheets to assist with the number-crunching. Plug in your financial numbers at insure.com or smartmoney.com.

Buy at the office. Take advantage of group life insurance offered at minimal or no cost through your employer. Many companies, however, will only match an employee’s salary. For more coverage, you can scan the supplemental coverage at work but make sure to shop around too.

It’s not that much money. Don’t be surprised if you need as much as $1 million in coverage. As a general rule, younger couples should look for a policy worth five to 10 times their annual income. A 35-year-old healthy, nonsmoking male can purchase a $1 million, 30-year term life policy for about $700 a year, according to insure.com. Also check selectquote.com or a local insurance agent or direct seller.

Term vs. Perm.

Term life provides coverage over a set period, say 15 to 30 years, and then expires. Permanent life insurance, which comes in many varieties, lasts until your death.

Start with term. Most consumer advocates and financial planners recommend starting out with term life insurance, which is the most affordable option and easiest to understand. It makes sense if you’re trying to ensure there’s money for the kids’ college or paying off the mortgage and other debts over 20 years. The beneficiary can receive a lump sum payout. The premiums are the same for the duration of the contract.

What about perm? Permanent, or whole life, insurance won’t expire after so many years. It’s significantly more expensive but these policies also build up a savings account that grows tax-deferred. Another option are return-on-premium policies that give back your money after the term ends. In both cases, many insurance experts recommend taking the savings from buying term life and investing them on your own.

A hybrid option. Check whether a term life policy allows you to convert it into whole life coverage later on. These “convertible” policies can be useful if you develop a chronic health condition that makes it difficult to qualify for new coverage after your term expires. Conversions, however, can come at a steep cost. Answer some questions at these sites to see what product makes sense for you, such as Life Happens or Bankrate.

Check rates, returns and ratings.

Opportunities to save. Rates are very competitive on term life policies and numerous quotes are available online at Insure.com, SelectQuote and other sites. Consider paying your premium annually to avoid extra fees for monthly payments.

Be a skeptic. For whole life, be skeptical about the rate of return companies promise in their illustrations showing dividends paid out over the policy. Also, whole life policies can have high fees and administrative costs that drag down the yield. The Consumer Federation of America will analyze illustrations for consumers for an initial fee of $85; then $65 for each additional one.

More than premiums. Don’t fall for the lowest premium without checking the insurance company’s rating for financial soundness. You want to make sure the company is around in case you aren’t. Many websites offer reports from the major insurance-rating agencies such as Standard & Poor’s and A.M. Best.

What not to do when buying a life insurance policy:

Don’t wait. Postponing your purchase until you’re older and sicker will make your policy more costly, if you get one at all. It’s best to lock in low rates when you have a clean bill of health and can sail through an insurer’s medical exam. If you do smoke or have a medical condition, be sure to fess up.

Don’t overlook a spouse. When one spouse (you) dies, the lifestyle of the surviving spouse can change drastically. Even if a parent doesn’t work outside the home, it would cost money to replace their childcare and other household duties.

Don’t let go. Letting a policy lapse after a few years. It’s tempting when the household budget gets squeezed, but the surrender or cash value on a whole life policy won’t equal the premiums paid until 12 or 15 years have passed. Term life doesn’t build up cash value.