Friday, February 19, 2016

Life Insurance 101

This week was Valentine's Day, and I want to tell you what I got for my significant other:

  1. A lovely potted flower
  2. A lovingly prepared dinner
  3. ...and a life insurance policy
Am I romantic or what?

I know, getting someone a life insurance policy as a gift might be about as exciting as getting them a vacuum cleaner, but I have to tell you, both are very much needed!  Besides, nothing says "I love you" more than making sure they are taken are of if disaster occurs.  I know those of you that are in your 20's and 30's are going to be tempted to dismiss this post and tell me that you have time to do it later, but I am going to urge you not to drag your feet on this one.  If you are in decent health right now, you will be insurable.  If you wait until later, and your health declines, you could find that you are uninsurable, or that the premiums are going to be much higher than they would be if you bought a policy earlier in life.  Also, do not think that just because your work place has insurance on you that you are fine.  It is likely enough to cover funeral expenses but little more.  You will have that as long as you work there, but not any longer.  Also, you need to give your family a little more financial peace than simply "getting you buried," right?

If there is anyone that depends on you financially, then you need life insurance.  There are primarily two things that you need to consider first and foremost:
  1. How much money do you need the death benefit to be?
  2. Which type of insurance should you buy?
So, the first questions "How much life insurance do I need?"  There are a TON of theories on this.  Some folks say that you need at least 20 times your annual income.  This is a million dollar death benefit for someone that makes about $50,000 per year.  Sounds like a ton right?  Well, there is another reason for this.  If your loved one gets paid out a million dollars and invests it all.  If they got a 5% return, and only lived off of the interest, they would be able to replace your salary without ever touching the original payout amount.

Is there a minimal amount of life insurance you need?  Something less than a million dollar policy?  Well, this is something that you need to really think about.  Evaluate your family's honest needs.  Do you have children?  If so, would there be childcare needs, etc?  If there are not any children, does the other adult have the ability to support themselves?

Let me tell you the manner in which I evaluated my family situation.  My family (household) consists of two adults, both of which are able to support themselves.  When only one of us is working, it is very tight but doable.  Knowing this, I have elected to purchase  policies on both of us.  The death benefit is enough to allow us to pay off our house and have two years worth of the other person's income.  I feel as though this is an amount that will safeguard my family, but I would also be pretty leery of having a death benefit that was any less than this.   This dollar amount would allow the survivor to live mortgage free, which would drastically cut down the remaining monthly expenses.

The second question is "Which type of insurance should I buy?"  There are a few basic types of life insurance:
  • Whole Life
  • Universal Life
  • Term Life
Most people will be just fine with term life.  Term life is just a straight up insurance policy where you decide how long you need to be insured, and the dollar amount you need as a death benefit.  People with children frequently choose a term based on how long they will be financially responsible for children.  They do this thinking, "I know my spouse will be able to support him/herself once the kids are grown."  This is a pretty logical choice.  Others choose a term that relates to their retirement age.  Once their spouse will be able to collect their retirement funds, social security, pensions, etc., they feel confident that those items will take care of their spouse, and feel that they no longer need the insurance.  Remember, when the term expires, your policy is done.  Also, generally a term life insurance policy usually has a fixed premium (at least for an initial span of time), so the younger and healthier you are when you get one, the cheaper it will be.  Of course there are special types of term policies that allow you to continue coverage once your term is done.  Typically, these policies offer a smaller death benefit after certain ages (they decrease after 65, 75, etc.).  The premiums usually also increase when you switch age brackets.  When I was shopping, I notice "TERM" life and "LEVEL TERM" life insurance.  So, if you are looking at term life, be sure that the company doesn't have multiple kinds of insurance policies that fall into the "term" category.  If they have multiple types, make sure you know what you are getting.

Whole Life and Universal Life are considerably more expensive.  While a term life insurance doesn't have any "cash value," meaning they aren't worth any money unless the insured passes away.  These other types of policies carry a cash value.  It is sort of like it is half investment and half insurance.  As long as the premium is paid, you could conceivably keep this type of policy for your entire life.  Now, that does come with a price.  They have a more expensive premium for sure.  For most people, I think TERM make more sense.  I personally like to keep my investments separate from my insurance policies, however, if you feel that your circumstances warrant coverage for longer than a 10, 20, or 30 year TERM policy will allow, you should investigate this type further.

I am NOT licensed in insurance in any way.  Someone that is licensed in insurance can give you a great deal of information with regards to any policy types that you are interested in.  That being said, I would warn you against going blindly into an appointment where insurance is involved.  An insurance salesperson is exactly that, a SALESPERSON.  While they have a lot of knowledge that can help you greatly, it is also their job to sell policies.  An honest and reputable person will only help you to get into a policy that will benefit you, but still, you need to be your own expert.  You CANNOT go into an appointment having no idea what you want, or what you need.  If the sales person operates on commission, they will make money from selling you more expensive policies.  Also, no one cares more than you about your family.  You have a lot of reason to want to make sure that you know what you are getting, and that you are getting what you want and need.  Don't let someone determine that for you because you "don't know" or are too afraid to take a hands-on approach.

More to come on insurance on future posts.  Hopefully, this will get you started toward making some choices that will allow you to sleep well at night knowing you family will be safe.

Monday, February 1, 2016

Credit Cards and Credit: How many is too many?

Sometimes people contact me in order to ask certain personal finance questions.  I received one question today that I felt was worth bringing to your attention.  This person was recently denied a credit card for having "too many open accounts."  It is true that this person has several credit accounts, but is not maxed out on any of them.  Furthermore, this person has more credit available than what they have in use, and make all payments on time.  In other words, they have relatively low balances.  This person was confused about the decline because they felt as though they had been doing everything in a responsible manner.

In general, a person with "too many credit cards" presents a higher risk to the lender.  Lenders especially dislike seeing a number of credit inquiries in the past 12 months.   They look upon it poorly.  They  think to themselves, "Why does this person need so much credit?"  Let's consider this from another perspective (the lender).  Having too many credit cards is a somewhat opposite problem as that of having no credit cards, but a problem nonetheless.  When a lender sees someone with no credit cards they think "How do we know you're going to pay us back?  You have no track record."  With someone that has too many, they think "Danger, danger!  Red alert!  If this person's financial world turns upside down, what are they gonna do?  Max out all of these credit cards, then we will be one of 10 companies in line with our hands held out!  No way!  Stay away from that one!"

...And you have to admit, they have a point.  One of the risks that they take when they lend  to you is the fact that the credit card will be unsecured debt, meaning they can't come and repossess anything in order to make their money back if you fail to pay.  Quite frankly, if you were to file a bankruptcy, they very well might be out of luck! So, when they see "too many accounts," they tend to get a little skiddish.

Now for the magic question...  How many credit cards is "too many"?

Unfortunately, there is no right answer to this question.  Since there are a number of things that compose your credit, and each individual situation is different, that can't be boiled down to one simple number.  With that being said, here are a couple of guidelines.

  1. If you don't need to credit, don't open the credit card.
  2. Aim to have only 2-6 credit cards.
If you have more credit cards that this, don't rush out and start closing your credit accounts.  That could lower your credit score by making it look like you have a higher amount of debt compared to the credit available.  This is one of the factors involved in the composition of your credit score.  

For further information about what goes into composing your credit score, try going to the websites of FICO, Equifax, Experian, or Transunion.