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7 myths surrounding life insurance

When it comes to life insurance, even smart shoppers can get tripped up by myths and misperceptions.

Unfortunately, any mistake you make when buying a life insurance policy can have long-lasting consequences. And if your family is not provided for the way you intended, you won't be around to fix it.

You may not have a second chance to make the right decision. To choose the life insurance that's right for you, steer clear of these seven most common myths surrounding life insurance:

Myth #1: Savvy wage earners should buy seven times their annual earnings.
You may think that because you've followed some rule of thumb that says you should have four, five, seven or some other multiple of your annual income, that your insurance policy will be enough to provide for your loved ones.

That may or may not be the case. Consider this: The average American has a policy for about three times his or her annual income, says David Woods, president of the Life and Health Insurance Foundation for Education, in Washington, D.C. Many financial experts say that as a general rule of thumb, you can withdraw about 5 percent each year from the earnings on a sum of money before you have to touch the principal.

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So, if you're making $60,000 annually and purchase three times your annual income, or a $180,000 policy, your heirs would be able to safely withdraw only $9,000 each year. "As a general rule, people underestimate how much life insurance they need to generate enough proceeds to adequately support their beneficiaries," says Mario C. Giganti, CFP, CPA and managing director with Azsure Fiduciary in Uniontown, Ohio.

To calculate how much insurance you'll need, estimate how much your heirs will need to maintain their lifestyle without you. Don't forget to include additional costs they may face in your absence. If you've got young children, for instance, child care costs likely will rise. You also may want the policy to help fund their college education. For more help visit Bankrate's interactive calculator.

Then, add up all other sources of income, such as your spouse's salary or pension, and any Social Security or other government benefits for which they would be eligible. Your life insurance policy should help close any gaps.

Myth #2: The best deals are obtained over the Internet, bypassing agents' commissions.
"I bought over the Internet, so I must have gotten a great deal."

The Internet is a great place to shop around and check prices. However, you can't assume that you've automatically gotten the lowest price. "If you find a good, reputable agent and they do the job, they'll find a competitive rate that's comparable to what you can find online," says Giganti.

What's more, the premiums posted on some Internet sites can be misleading. For instance, they may post a rate that few people will qualify for. Or, they may promote an initial rate, and neglect to mention that the premiums will increase over the term of the policy.

In addition, simply comparing rates won't tell you how well the policy fits your needs. "One downside to buying online is that the consumer may not a do a sufficient job of assessing (their own) needs," says Bob Puelz, professor of insurance at Southern Methodist University in Dallas, Tex. Before shopping for prices, figure out how much coverage you need, and what type of policy will work best.

Myth #3: Except for the amount, all insurance policies are the same.
"I don't need to read the policy," many people say. "Besides, I wouldn't understand it."

Wrong. Your life insurance policy is a contract between you and the insurance company. It spells out what you need to do to obtain and maintain coverage.

It also will identify situations in which the insurance company won't cover a claim. This may happen, for instance, if the policy holder commits suicide within a year or two of the issue date. It also should indicate whether the premiums will remain the same during the term of the policy.

Finally, you'll want to verify that the policy accurately reflects the information you supplied in your application. Is the name of the beneficiary correct? Mistakes could cause problems later on.

Granted, sitting down to review an insurance policy doesn't sound like much fun. However, it's worth the time.

Myth #4: The smart move is to name your estate beneficiary.
If you do, the proceeds of the policy then have to go through probate, says Michael Horbal, president of LifeInsuranceAdvisors.com, LLC in Newtown, Pa. Probate is the process by which the courts verify that a will is valid. Depending on the size of your estate, probate can take several months or a year or more. During this time, your heirs wouldn't be able to access the proceeds from your policy.

In addition, including the proceeds in your estate will increase the value of your estate, which may mean you'll have to pay estate taxes. If your estate is valued at more than $1.5 million, you'll probably have to pay estate taxes, says Julie Welch Runtz, CFP, CPA and director of tax services with Meara King & Company, in Kansas City, Mo. Given that estate tax rates can hit 48 percent, you'll want to do all you can to avoid them.

Myth #5: People in poor health can't get insurance.
Don't assume that you won't be able to get coverage because you're living with a serious illness, such as diabetes or heart disease. "A lot of companies specialize in this type of coverage," says Horbal. "It may be more expensive, but you can get it.

Even if you've been declined by one company, that doesn't mean other insurers also will decline coverage. What's more, one company may cover you only if you pay an added surcharge, while another may charge you its standard rate. For instance, one cholesterol reading might give you a standard rate with one company yet qualify you for a preferred rate with another, notes Horbal. "You really need to shop around."

Myth #6: Insurance agents are experts in determining what you need.
Many life insurance salespeople and other financial professionals truly look out for their clients' best interests. However, it's important to remember that some are compensated differently for selling different products. That may influence which products they recommend.

For instance, some agents work for companies that sell only permanent insurance, such as whole or universal life. As a result, they're less likely to recommend other types of insurance, such as term policies. "Cash value (whole life) polices often are pushed heavily by companies that don't compete in the term market," says Horbal.

If you need help, a CPA familiar with your financial situation is probably your best bet for advice on what type and how much life insurance you should buy.

Myth #7: Life insurance is far more important than disability coverage.
Many people are aware of the importance of purchasing life insurance. They're less likely to recognize how important it is to purchase disability insurance. That can be a big mistake. If you're under age 50, you're 50 percent more likely to be disabled for a period of time than you are to die, says Giganti. "Most people underestimate the fact that they could become disabled."

Given the odds, most people will find that it makes sense to purchase term life insurance, which is less expensive than permanent. Then, they also need to purchase disability insurance.

Karen Kroll is a freelance writer based in Minnesota.

-- Posted: July 28, 2004

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