NerdWallet: Big life insurance blunders can cost more than money

Life insurance provides a financial safety net for families. Sounds simple, but decisions over whether and how much to buy can get complicated, and mistakes can be costly.

Here are common mistakes financial planners see:

Buying too much or not enough

Not everyone needs life insurance.

"If there's no one else depending on your income, you probably don't need much or any at all," said Alyssa Lum, certified financial planner and founder of Luminate Financial Planning in Sterling, Virginia.

But those with young children will need a lot. For breadwinners, a rule of thumb is at least seven times your annual salary, plus money to pay off debt and fund college. "Those dollars really add up," Lum said.

Stay-at-home parents don't need as much, but should have some coverage, said Greg Klingler, a certified financial planner and director of wealth management for the Government Employees' Benefits Association. Buy enough to cover child care and other services the stay-at-home parent provides.

Buying the wrong policy

There two main types of life insurance: term and permanent.

• Term life insurance is simple, cheap and offers coverage for a certain period, such as 10, 20 or 30 years. It pays out if the policyholder dies during that term.
• Permanent life insurance, such as whole life, lasts your entire life and includes a savings component called cash value, which grows slowly over many years. You can borrow against the cash value or surrender the policy for the cash. It's more complicated and expensive than term life. It also nets the highest commission for insurance agents.

Term life is the best choice for most families, Klingler said, because "most people are going to have a finite need." Term life can cover you while the kids are growing up or you're paying off debt, such as a mortgage. Ideally, at the end of the term, you don't need life insurance anymore.

Yet some people get talked into permanent policies when all they need is term life, said Jason Speciner, a certified financial planner in Fort Collins, Colorado. Building cash value inside a policy can sound appealing, but fees and the agent's commission eat away at returns. Instead of pouring money into a permanent policy, max out savings in tax-advantaged retirement accounts. If there's money left over for long-term investing, a low-cost index fund will probably produce better returns than life insurance, he said.

"In most cases, the old saying, 'Buy term and invest the difference,' makes sense," Speciner said.

Permanent life insurance can be an important estate planning tool for those who have a lifelong financial dependent, such as a child with special needs, or whose estate is big enough to incur taxes for heirs. (Only estates over $11.18 million for an individual and $22.36 million for a couple are subject to federal estate taxes in 2018.)

Putting off the purchase

It's easier to put off buying life insurance than think about how your death would affect others.

"But that's a pretty risky gamble, especially if you have small kids," said Michael Kelley, a certified financial planner in Cleveland.

Worried about the cost? It might be cheaper than you think. Most consumers overestimate the price of term life insurance by more than three times, according to a 2018 study by industry groups Life Happens and LIMRA. The study was based on a survey of about 2,000 adults who are household financial decision-makers. The actual cost of a 20-year, $250,000 term life policy for a healthy, 30-year-old nonsmoker is about $160 a year, the study states.

Compare quotes from at least a few companies to find the best rates.

Relying on free life insurance at work

Life insurance benefits through work probably aren't enough for those who have a family depending on their income, Speciner said.

That coverage is typically one to two times your annual salary -- not enough to sustain a family after the loss of a breadwinner. Another drawback: The coverage usually ends when an employee leaves the company.

Buy your own policy if you need life insurance, and consider the free benefits from work a bonus.