It’s simple really: your ‘Before Getting Pregnant‘ to do list should have sorting out life insurance as a top priority. With a new child come new responsibilities; working towards financial security sees you well-prepared in facing any unplanned eventualities.
Scott W Johnson from Whole Vs Term Life Insurance shares with Dreaming of Baby the factors you have to consider when shopping for insurance as well as the differences between ‘term’ and ‘whole life’ insurance.
Charles: Good afternoon Scott, it’s a pleasure to welcome you here today to add to our discussion on the financial considerations parents-to-be should be taking in their journey to parenthood. Our subject today is insurance – before we delve in though, it would be great if you could introduce yourself and your experience in this field to our readers.
Scott W Johnson: I am a Licensed Life and Property Causality Insurance Agent based in California. I own an independent insurance agency. I truly believe in consulting with clients and assisting them in making informed decisions.
Creating a safety-net prior to parenthood
Charles: Thank you for the introduction; it is very often that as we move into a new chapter in our lives; specifically, the path towards parenthood, it becomes more important to have an added layer of security. Parenthood brings with it new responsibilities and it’s easy for parents-to-be to feel slightly overwhelmed at the realization that they will soon have someone completely dependent on them. What should parents-to-be be aware of in terms of creating a safety-net and insurance?
Scott W Johnson: There are multiple things to be aware of when you are expecting a new addition to the family. Being a father of two myself, the first piece of advice I have for new parents is less about insurance and more about bill paying. Bringing home that first child changes everything. You may not be that type of parent who misses bill payments but you might after not sleeping for six weeks straight. So, I generally suggest that clients first consider setting up important bills on auto pay and do as much planning as possible before their children come. The next thing to consider is that they are increasing the size of their family. With that increase comes added financial responsibility.
Scott W Johnson: “I generally suggest that clients first consider setting up important bills on auto pay and do as much planning as possible before their children come.”
Charles: With that added financial responsibility what are the main vehicles for protecting the family?
Scott W Johnson: Well, there are a number of insurance considerations. Often the most obvious is the need for life insurance. Generally speaking, both parents, working or not, need some form of term life insurance. Sometimes you have a situation where one person gives up work in order to stay home with the child. When that parent makes that choice, sometimes that means that they may be giving up a Group Life policy at work, so that needs to be taken into consideration. Another consideration is the Auto Insurance. If for example, your family is moving from two to three, you will want more liability and specifically uninsured motorist coverage.
Charles: In terms of Group Life policies, can these be transferred or do you generally need to set up a completely new policy?
Scott W Johnson: It would depend on the Group Life policy. But in general, if you are healthy, it’s usually better to set up your own term life policy that you own and you manage. Honestly, term life can be really cheap these days.
Scott W Johson: “Generally speaking, both parents, working or not, need some form of term life insurance.”
Charles: Can you walk us through a few of the options with regards to life insurance?
Scott W Johnson: Absolutely. There are group life plans, often available through work. Commonly they are One or maybe Two Times earnings. Sometimes you can add more, and you would be responsible for paying for the extra. But this all depends on the organization that you work at. Many employers have no such benefit.
Scott W Johnson: Then there are individual life insurance plans. Let’s loosely group them into two types: A form of insurance that mixes a “Cash” and an Insurance product. There are various versions of these, the most common are universal and whole life insurance. Then there is a form of pure life insurance known as Term Life insurance. Term is very cheap in comparison and much easier to understand.
How do you calculate how much life insurance to take?
Charles: How would one go about calculating how much life insurance to take? (the payout).
Scott W Johnson: Great Question! Figuring out how much life insurance seems harder to do than most people think. The old method of calculating it was to multiply ten times your earnings. So, if you make $50K per year that would mean that you should get $500K in insurance. However, this method has drawbacks. Often its best to speak with either an adviser or a skilled insurance agent to discuss a firmer calculation method.
Charles: Wow, ok so as a general guide it would be 10 years income but as you stated above other factors do come into play. Is the payout figure taxed?
Scott W Johnson: Life insurance payouts are generally income tax-free. There are other tax considerations such as inheritance taxes, etc. And sometimes income tax can hit it in certain rare situations.
Charles: Also, is there any way for the policyholder to control the disbursement, for example, allocating a portion to education for the child or making arrangements for the money to be paid out yearly as opposed to all in one go?
Scott W Johnson: Well, the death benefit can be allocated out, with a certain percentage going to various people. Say 50% to one child and 50% to another child. You can also meet with a lawyer and create a version of a trust that could be the recipient of the money. The trust would then have its own rules about how and when the money would be used.
Charles: That makes sense, and I assume trusts can be set to pay out at different times including at certain ages for the recipients?
Scott W Johnson: Well, a trust is a legal vehicle and all sorts of rules can be set up with it. My general answer to most legal questions is to refer them to a lawyer.
Charles: I know my colleague Daniela has some questions for you, so I am going to step out and let her continue. It has been educational and a pleasure.
What is the difference between term and whole life insurance?
Daniela: Good afternoon Scott, a pleasure to be speaking with you today. I do have some questions for you which we’d appreciate your insight on. Going back to the basics so to speak, what is the difference between term and whole life insurance and what are the determinants that parents-to-be should consider before deciding on which to go for?
Scott W Johnson: Well, whole life insurance lasts your whole life. It is far more expensive, sometimes 8,10, or maybe more than 12 times as expensive. It is a pretty rock-solid place to put money, but generally speaking it can only make sense if you can easily afford it for your entire life. The real value of it is not realized until most clients have had it for more than 14 or so years. Lastly, with whole life I find it is hard to compare one policy with another, so it is not like shopping for a savings account.
Scott W Johnson: Term Life is pure insurance and is very easy to shop from one carrier to the next. The premium is level for a certain number of years after which you would cancel it. You can get lots more insurance during that time period vs whole life. In my professional opinion, term life insurance fits fairly well with new parents. “Congratulations, here is a wonderful new child, now he or she will likely cost $50K per year for the next 21 years.” What happens during that 21-year period if mom or dad does not come home?
Scott W Johnson: Whole life may be a better fit from a long-term financial plan in some situations, but buying right after you have your first child could be a financial challenge.
Daniela: I understand; the financial responsibilities that come with a new child are substantial, as you have noted. For the parent-to-be looking into term life insurance, what should they be looking into in terms of making an informed choice?
Scott W Johnson: “Whole life may be a better fit from a long-term financial plan in some situations, but buying right after you have your first child could be a financial challenge.”
Scott W Johnson: First off, speak with a few insurance agents. Ask them what rate they think you will qualify for. A good insurance agent will ask about your family’s health history, your health, medicines taken, your travels, and fun things you like to do. If an agent does not discuss these items then they cannot get you an accurate quote. Also, check the Financial Strength Rating of any insurer that you considering buying from. Lastly, do not let an insurance agent bully you into buying something that you do not understand. Ask questions and work with someone you trust.
Should I purchase life insurance when pregnant?
Daniela: Thank you for that. You mention health: how does this affect the term life insurance and is there a difference between buying before pregnancy and buying whilst pregnant? In other words, should purchasing a plan be something you must do prior to pregnancy?
Scott W Johnson: Well, your overall health profile helps to determine your health class. A medical exam is typically done at your home where the paramedic examiner will take some measurements and some tests. When you are pregnant, this can change many of the readings and can make it harder to secure a life insurance policy. Therefore, it’s not ideal to do it while you are pregnant.
Scott W Johnson: “When you are pregnant, this can change many of the readings and can make it harder to secure a life insurance policy. Therefore, it’s not ideal to do it while you are pregnant.”
Daniela: If I understand well then, sorting out life insurance should ideally be on the ‘before getting pregnant’ to do list. You also mention that an applicant would be asked about their travels. How would this affect the process?
Scott W Johnson: Mainly they want to see how often you have been to (and in some instances, are planning on going to) dangerous countries. Do you go for work and routinely or just now and then? The best example is an expat that spends most of their time in a third world country where they don’t have seatbelts. You can imagine an insurer balking at writing that policy.
Daniela: True! In terms of payouts and tax, would this be the same as with whole life insurance?
Scott W Johnson: Not necessarily. Whole life insurance is more likely to get hit with taxes, although it is still pretty rare. Partially because of the nature of the vehicle. The policy could become overfunded and be in violation of an obscure insurance law making it essentially a Modified Endowment Contract. Also, whole life insurance policies have a bad history of people bailing on the policy before the end of the policy, which is their whole life. When that end comes about, it’s also possible to get hit with a tax.
Daniela: Thanks for clarifying that – with regards to term life insurance, what happens if it’s stopped before that term expires?
Scott W Johnson: Term is easy. Since there is no cash account, the policy just ends.
Daniela: Would the premium be lost though in such a case?
Scott W Johnson: Generally, people pay their term policy yearly. That yearly bill once paid, insures you for that full next year. So, when the next term bill comes around for the next year you would just opt to not pay it. The premium would not really be lost as it would apply another year’s worth of coverage.
Daniela: Thank you for clarifying that, very helpful. On a closing note, is there anything else you wish to share with expectant parents on the subject of insurance and which we might not have covered in our conversation?
Scott W Johnson: Yes, two things. First: please increase your Uninsured Motorist now that you are increasing the size of your family. Raise it to the highest level that you can afford. Secondly, if a lawyer has you create a Revocable Trust, make sure you tell your insurance agent and have the trust added as either an Additional Insured or a Named Insured. (Uninsured motorist is auto; Trust is for home insurance.)
Daniela: Thank you for the insight you’ve shared with our readers today, Scott! It was a pleasure speaking with you!
Scott W Johnson: Thank you!