Debunking the Top 7 Life Insurance Misconceptions

Only suspicious widows in murder mysteries buy life insurance. Life insurance is the misunderstood villain of financial products. It’s often a plot device or an afterthought in employer-provided benefits, even though it can protect your dependents from years of financial struggle. Many misconceptions about life insurance prevent people from obtaining coverage or cause them to buy the wrong type.

Is life insurance too expensive? In this article, we will break down 7 common myths and set the record straight so consumers can make confident, informed decisions about whether life insurance is useful for them.

Misconception #1: “Life Insurance Is Too Expensive”

The reality is that term life insurance can cost less than $20 a month if you qualify for low premiums, but can also cost over $500 a month.

So what’s up with the variance? Well, life insurance premiums depend on your age, health, and policy type. All insurance product costs depend on your individual risk. Are you a heavy smoker? Your life insurance will cost more. This is just like how if you’re insuring your car and the insurer sees you’ve crashed your car five times in the past year, your auto insurance premiums will skyrocket.

You can stick to your budget and still obtain an affordable life insurance policy if you buy early or are relatively healthy.

If you have a list of pre-existing medical conditions longer than this article, you will have trouble getting cheap life insurance. Smokers, for example, will encounter significantly higher life insurance premiums than non-smokers.

Comparing life insurance policies can help you obtain a better rate. This can be great because when you buy term or whole life insurance, it locks you into that amount for the term or the rest of your life. After the policy is issued, whole life insurance premiums won’t increase as you age.

Misconception #2: “I Don’t Need Life Insurance if I’m Young and Healthy”

Many young people believe that they do not need life insurance. This depends on your situation. A lot of the time, even young people have dependents, debts, or future family obligations. Common ones include:

• Spouses
• Co-signed debt
• Student loans
• Mortgage planning

A major benefit of locking in coverage early is that you can obtain lower life insurance premiums. Life insurance premiums increase as you age. If you get diagnosed with a health issue, it can greatly impact your life and health insurance premiums.

If you opt for a permanent life insurance policy, holding the policy for a long time over the years can help you accrue greater cash value. This works for some people, but be aware that permanent life insurance policies aren’t money-efficient for everyone. Term life insurance is much cheaper and doesn’t lock you into a big financial commitment.

On the other hand, if you are single, don’t plan to have children, your parents/family are wealthy, or just expect to have no dependents in the next ten years, it might not make sense to have life insurance. The payout would not go to any beneficiaries who need the financial support.

To answer the question of when should you buy life insurance: the right time depends on your individual and family circumstances. Also check out our guide on When You Should Write a Will.

Misconception #3: “Only the Breadwinner Needs Coverage”

Many families that buy life insurance only insure the main income earner if the partner is a stay-at-home parent. However, the reality is that stay-at-home parents often provide critical economic support. Doing household chores means not needing to hire a cleaner. Taking care of a child is a full-time job. Lower income still counts as economic value.

Depending on your combined family income, budget, and financial situation, it may or may not make sense to get coverage for non-income contributors as well. In today’s economy, many families rely on two incomes to survive. Life insurance for both spouses protects the family against financial instability in case one partner passes away. The non-breadwinner should consider getting life insurance as well if:

• They contribute economically to the family
• There is shared debt
• They are stay-at-home parents providing essential household support
• The family would struggle financially if they pass away
• An estimate of a $10k funeral is too expensive for the dependents

Imagine, the non-main income earner passes away. The surviving spouse might need to pay extra for daycare, cleaning, food planning and delivery, which were previously free.

Another crucial point of consideration is debt. Shared debts don’t vanish. Any co-signed loans, mortgages, credit cards, or financial obligations will go to the surviving spouse. These amounts can snowball into a financial disaster if suddenly there is only one or no income.

Misconception #4: “Life Insurance Through My Employer Is Enough”

Employer-provided benefits range from covering health issues to providing PTO. However, most employers offer limited term life insurance. If the life insurance plan only pays out 1 to 2 times your salary, the death benefit might not be enough for your dependents.

The employer life insurance payout amount can cover your dependents’ essential needs for two years, but what about mortgage? If your dependents can’t pay the mortgage consistently, the property can face foreclosure. Your children’s future tuition a decade down the line? College and post-secondary costs can be extremely expensive, and counting on a full-ride scholarship is far too risky. Two years of the policyholder’s salary is rarely enough.

Another major risk is that employer life insurance might end if you change your job, though this depends on your employer’s specific policies. If your employer provides permanent life insurance, they may let you transfer your life insurance when you move to a different job. You may also be able to accrue cash value and surrender the policy for cash. But this is rare.

If your employer or organization has a group term life insurance plan, that’s great. However, consider your dependents’ financial needs to see whether an individual policy could be useful as supplemental life insurance.

Misconception #5: “Life Insurance Payouts Are Always Taxable”

“Nothing is certain except death and taxes.” The popular quote applies to life, but fortunately not everything is taxed. Death benefits, for one, are generally income tax-free. This means that if you pass away and your beneficiaries receive the death benefit, the lump sum amount will not be decreased by taxes.

Exceptions exist. The only times life insurance payouts need to be taxed are in special circumstances. Let’s review some common ones.

Estate taxes: If there are estate tax requirements, you might need to pay an estate tax (not an income tax). This happens if you have no beneficiaries for your life insurance policy, then it goes to your estate. If your estate amount exceeds the current federal estate tax threshold (usually around $13 million), estate taxes would need to paid for the amount over the limit. State estate regulations may also impact whether the death benefit would need to be taxed.

Death benefit over time: If a beneficiary chooses the death benefit as an annuity (over time instead of as a lump sum), interest accrued by the annuity over the years may need to be taxed. This is generally why most people choose to simply take a lump sum. Then they can use the lump sum for investments and essential payments.

Loan or withdrawal: If you choose to take out a loan against your accrued cash value (for whole life insurance policies), you may need to pay an income tax. This depends on the amount you take out as a loan. In cases where you withdraw more than your cumulative premium, you would need to be income taxed on the excess.

Surrender or sell policy: If you surrender or sell your whole life policy, you can obtain a cash payment in return for some lost value. You may be charged a surrender fee before receiving the payment. If the surrender cash payout exceeds the cumulative premiums, the excess may be subject to income taxes.

Corporate life insurance policies: Corporate-owned life insurance policies may be taxed. If the transfer-for-value rule applies, it can complicate your tax situation. If you are an employer and have a group life insurance policy, the business needs a manager who understands when the business would be taxed.

Misconception #6: “Life Insurance Is Only for Covering Funeral Costs”

Myth, myth, myth.

The average full service funeral costs around $10,000. The exact cost will depend on the budget, cemetery, casket, vault, and other choices. According to Statista, funeral costs have been trending up, while life insurance purchase numbers have been trending down in recent years.

With consumer debt on the rise and funeral costs rising, it is critical for life insurance to provide a large enough payout that it can support the grieving family through various costs. Life insurance can cover a lot more than funeral costs. Life insurance policies can:

• Replace lost income
• Pay off debts
• Fund education costs
• Support legacy planning
• Provide cash value

When writing a will or buying life insurance policies, consider how much coverage you need. Take into account potential lost income, budget, debt, mortgage, tuition, and funeral costs. If your estate has complexities, a financial advisor, attorney, or insurance expert can help you with them.

Note: Burial insurance is a special type of insurance that indeed only covers burial expenses, such as cremation costs, funeral viewing and service, outstanding debt, and legal fees. Most people choose life insurance over burial insurance because life insurance’s lump sum payout is far more flexible.

Misconception #7: “It’s Too Complicated to Understand”

To be honest, we get it–insurance products do feel too complex sometimes. But we got your back. Here are the basic types of life insurance:

Term life insurance: You get life insurance for a set term (e.g. 10, 20, or 30 years). If you renew, premium can go up.

Permanent life insurance: AKA whole life insurance. Lasts your whole life. Premium stays the same. Accrues cash value that you can withdraw early.

Other essentials that are typically expected:

• You pay a premium every month
• If you stop paying for a while, you lose your coverage
• Cost mainly depends on your age and health risks
• You can choose the coverage amount

Optional life insurance riders (for customization) can be added to your insurance policy and vary by insurer and policy.

You don’t need to be an expert as a consumer, just informed enough to choose a suitable fit. Insurance advisors and educational resources, such as our Insurance Ranked blog, can help you better understand the intricacies of life insurance.

If you’re having trouble shopping for life insurance policies, here is a Step by Step Guide on How to Shop for Life Insurance.

Final Takeaways

Life insurance myths often prevent people from securing the right protection for their dependents. But life insurance is flexible and more affordable than you think.

We highly recommend comparing different life insurance policies to see what works for you. Review the best life insurance options and speak with a trusted advisor to make the best choice.