I recently received a mighty big question from  NM and thought I’d share it and my answer here since she is asking a lot of the same things many other people are asking and I can kill many birds with this one stone.  NM writes:

I recently bought your book and in it, you suggest Disability Insurance, Critical Illness Insurance and Life Insurance. I’ve made a spending plan and am trying to figure out how/when/where these insurance products would fit in. Now that you’ve convinced me insurance isn’t evil, I’m wondering… I’m 24 (about to turn 25), single, and I just started a new job in June grossing $33,000/year. I have about $6,500 owing on a line of credit at 8.5% interest and $2,000 on a credit card at 19.97% interest. My question is: do I need all three types of insurance? Should I get them now or wait until I pay off my debt? And how do I figure out how much disability or critical insurance I would need? I’m assuming that once I move out on my own or collect any assets I would need to look in to getting Critical Illness or Disability insurance?

NM, since you are single and young, you’re most important insurance step is to get disability insurance. Not any old disability insurance, but the very best disability insurance you can afford. (Tomorrow I will post a guest blog on disability insurance from a Guy In The Know, so read it.)  Life insurance is important when you have assets and dependants, and since you have neither, and are still very young, this doesn’t have to be a priority. Critical Illness insurance is also useful, but I often recommend it for those who can’t get disability insurance because they are old, and that’s not you. So, the best DI you can find, m’girl, that’s what you’re after.

NM went on to say:

Speaking of debt, I plan to pay off the 19.97% interest credit card debt and then start an emergency fund (meaning I will have a very small emergency fund until I pay off that high interest credit card). I was then going to put away about $300 per month for emergencies. 5% of my income goes in to my company’s pension plan; I was also thinking about increasing those contributions once I pay off the credit card. Should I save less and continue making huge debt repayments? Or should I work on boosting my savings even though it would take me longer to get out of debt?

Also, my company’s pension plan acts like an RRSP in that my income is taxed after the contributions are deducted. My company also matches my contributions. The plan is locked, meaning I can’t get to the money until I retire. Is there any downside to having this type of a pension plan (for ex. I can’t borrow against it to get a house, etc.)? I want to contribute the maximum to this plan, but I’m wondering if I should also get an RRSP?

Thank you for this book–I can hear your voice talking to me through the pages! I plan to use it to guide me in to being a Woman of Independent Means.

Good questions all, NM. Focusing on getting your debt repaid is the right thing to do, particularly since you are not ignoring either your long-term or emergency savings. When I work with my fams, I often start them off saving only $100 a month for each, just to get the habit established. You’re already doing this so go nuts on the debt repayment.

Since 5% of your income goes toward your company pension plan (which is fine, by the way) and they match your contributions, that means you’re saving 10% long term. Perfect. And $300 a month for emergencies until you get to the months’ worth of Essential Emergency Expenses is terrific. As for not being able to borrow against your retirement savings for a home, I’m not a huge fan of this strategy. Once you have all your consumer debt paid off, take the money you were using for debt repayment and start building a Home Downpayment Fund.

I’m glad you’re enjoying A Woman of Independent Means.  It’s always good to hear when people are using the book to make more sense of their money. I’m working on an outline for a new book, but if you stay this course you’re on, you won’t need it! Ha!

This is my final blog of the year, so I want to wish you all a very healthy and happy 2009. Last year I made a resolution that kept me sane through all my ups and downs. Being the stone in the river was one of the things that got me through the tough changes at the end of the year. (All your hugs and my emergency fund were the other two.)

We have been in our new home now for almost a month and things are settling down and developing a rhythm. I want to thank you all from the bottom of my heart for all your good wishes and kind words. I believe that it was being wrapped in your positive energy that made the last couple of months bearable. Now I can hardly wait to see what 2009 has in store for me!

The best to you all. I am so proud of so many of you for seeing the light and taking control of your money and your lives.

Hey, I’m almost out of success posts, so if any of you want to share your stories, please send them along so everyone else can be inspired by you, or can share their wisdom with you to help you along.

One more thing: Since we’ve covered a lot of ground in the past year, is there anything in particular you’d like more information about? I already know you want more on investing, so I’m going to work up some stuff on that. Anything else?

Cheers, with heaps of love, and great big hugs.

I friend of mine recently got a letter from his term insurance provider offering additional coverage for accidental death. This is one of the latest “pushes” from the insurance world. Of course, what they don’t tell you is that under 3% of all insurance claims are paid out because of accidental death. This makes accidental death premiums one of the most profitable for companies. Buyer Beware!

The other “push” I’ve been hearing a lot about recently is the push to replace existing life insurance policies with new and improved. Be careful. Some unscrupulous brokers encourage clients to switch policies to pad their own wallets. While term costs have decreased in the last few years, you shouldn’t be swapping an existing permanent plan for a term policy, particularly if you’ve had it for any length of time.

Speaking for insurance agents, watch out for those who are allowed to sell only one company’s products. Insurance companies employing agents generally charge higher premiums than do insurance carriers employing independent brokers.  Since an employee of an insurance company cannot shop for the best value for you, they may not offer the product best suited to your needs.

Remember, too, that the cheapest isn’t always the best, particularly over the long-term. So while a term insurance premium may look really cheap now, if you have to renew it a couple of times, you may be surprise at how much the premium increases over time. Look at the overall cost rather than just at the initial premium.

And watch for policy exclusions.  All life insurance policies have a two-year suicide exclusion. Some also carry travel or recreational activity exclusions if the applicant was engaged in these activities at the time of application. So if you’re an avid mountain climber, the policy probably won’t pay out if you fall off the mountain.

Each insurance company has its own underwriting guidelines and having a broker who works with multiple carriers and is up to date on the different underwriting protocols is the single best way to guard against buying something that doesn’t serve you well.

Before buying insurance, answer these three questions:

1. What do you want your life insurance to do for you?

• Pay for your funeral?
• Pay off your outstanding mortgage balance or other debts?
• Offset the loss of your income? For how long?
• Fund your kids’ education?

2. Who do you want to insure?

• You can get a life insurance policy on your own life, or you can get one policy for both you and your spouse (referred to as a joint life policy), which pays when the first partner dies, leaving the life insurance benefit to the survivor.

3. How long will you need insurance?

• When will your mortgage or other debts be paid off? The amortization period of your mortgage will often determine how long your term life insurance policy should be.
• When will your family no longer be dependent on your income? No dependents may mean way less insurance.
• When will your children be finished school? One day they’ll finish their education and having enough coverage to pay their educational expenses won’t be necessary.
• When are you planning to retire? You will have less income to replace at that time.

The more cash that is available from other sources, the less life insurance you may need so you should do a complete net worth before you start looking at how much insurance to buy. People often buy a policy here and a policy there until they have an insurance hodge-podge that can be confusing and over-priced. It makes sense to have Enough insurance. It makes no sense to have too much.

And so the life insurance joke is born:

I bought a new life insurance policy but the small print is impossible to understand. All I’m sure of is that after I die, I can stop paying.

Buying insurance is what keeps people poor so that they can end up dying rich.

Life insurance agent to a would-be client: “Don’t let me frighten you into a hasty decision. Sleep on it tonight. If you wake in the morning, give me a call and let me know.”

Despite the fact that life insurance has a bad rep, there are still good reasons to buy. Course, not everyone believes that.

Some people believe if they don’t work outside the home they don’t need life insurance. With no paycheque to replace, premiums seem like a waste of money. So, answer me this: with the other guy at work all day, who will watch the kids, do the laundry, drive hither and yon, make dinner, do the laundry, vacuum, grocery shop, do the laundry? How much would it cost to replace you?

Young people know they are never going to die. And if they do, it’s a long way off. Since the odds are in their favour, life insurance premiums are a waste of money. This is a paradox since if you buy your life insurance when you are young, you’ll pay so much less for it. Let’s be reasonable here, don’t you think a life of peace of mind is worth a few hundred bucks a year? Course, if you’re a gambler by nature and choose to take your chances skipping life insurance completely I only have one more question for you: how come your stuff is worthy of insurance, but your life isn’t? Maybe it’s because YOU don’t have to deal with the ramifications of your own death so it’s easy to ignore them.

Since many people are covered by life insurance through their benefits package at work, they believe that individual insurance is a waste of money. Have you even reviewed how much your work insurance provides and calculated whether this is enough to support your family? And when you leave that job for the next, will you still be young and healthy enough to get the insurance you need because the work plan just doesn’t cut it?

Then there are also people who avoid buying life insurance because they simply don’t want to think about their own demise. Ya know what? You’re gonna die. Yup. You’re gonna. So get over yourself and do what it takes to make sure your family isn’t left holding a Pot of Nothing when you’re safely pushing up daisies.

Almost everyone needs life insurance. Unless you plan to lead a solitary life and have no one that depends on you, you’ll probably need insurance at some point. The longer you wait, the more expensive insurance coverage will be, and the greater the risk that you won’t qualify because you develop some hither-to-unknown disease. Get coverage as early as possible so it’s cheap. And quit procrastinating. It’s not going to be any more convenient next Thursday.

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Don’t we just hate thinking about life insurance. It means considering our own demise. So instead, ostrich like, many of us just say, “That’ll never happen to me.”

Sadly, aside from leaving our family totally unprepared for our demise, and unprotected financially, there’s another consequence to hating the very idea of life insurance. It means we’re just as likely to do it badly as to do it well. Here are eight common mistakes we make either when we’re buying our insurance, or in keeping it working well for us.

#1 We let the premiums make the decision for us. If you start from the premise that you can only afford to pay $x, and let that decide how much insurance you buy, then you’re going about it all wrong. You must first figure out how much insurance you need and then choose the type of insurance that will give you the level of coverage you’re looking for.

#2 We think of insurance as an investment. Well, it’s not. It’s risk mitigation. It’s just in case. It’s a necessary part of a sound financial plan. While certain types of insurance do build up money over time — products like whole or universal life insurance — that’s not the first reason for buying insurance. Insurance is about taking care of the “what ifs”. So the amount it will pay out to help your family cope should be your primary consideration, not the potential return on investment.

#3 We buy term because it’s the only game in town. The “term vs. permanent insurance” debate rages on. Term insurance, for which you pay only for the death benefit, may be the best fit for many people. However, other types of policies, such as universal life or second-to-die policies, may be a better choice in certain situations. Choose the insurance that’s right for you. Don’t pick something just because you’ve heard it’s what everyone should buy.

4. We confuse illustrations with reality. Life insurance illustrations are designed to show much a cash-value a policy will build over time. And a lot of insurance representatives got their wrists slapped because many of those illustrations implied consumers could count on their policies to be self-funding within a specific — often too short — period of time. But if you haven’t yet heard the news, illustrations are only projections of what may happen. They are not guarantees. The company’s rates of return may decline and earnings may not be sufficient to cover the premiums in the future. So don’t count your chickens.

5.We don’t check back to make sure we’re still well insured. At least every year or two, re-examine your policies to be sure they are still doing the job. If you got married, divorced, had a baby, or had a big jump in income, the amount of coverage may no longer be adequate. Or you might need to add a second, different type of policy, to meet new needs. You don’t have to buy from the same insurance company. Shop around.

6. We forget to change beneficiaries. Oyyy! I hear this one all the time. People, if you get a divorce, remarry, have a new baby, or if your partner dies, you need to review your insurance to make sure you’re not leaving a stash of cash to nobody — or worse, someone you hate! Imagine seeing the death benefits from a policy on your recently deceased spouse go to that person’s former spouse instead of you. Heads up. This is a far more common mistake than it should be when you consider the consequences.

7. We needlessly replace a policy. Sometimes it is appropriate to drop one type of life insurance policy and replace it with another, especially if your life circumstances have changed. But be careful about dropping a policy just to get a “better-performing” policy or for a cheaper premium. The flip side of this is people who automatically renew their term coverage, even when the reason for having insurance has grown up and left home.

8. We name our estate as beneficiary of our insurance. Insurance benefits are free of income tax to beneficiaries, but they face probate if the benefits become part of the insured’s estate. So make sure you’ve named a person (or people) as beneficiary — and not your estate — on your policies.

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