How to Buy Life Insurance

Choosing the best life insurance company

Shopping for life insurance might seem complicated, but you can break it down into a few simple steps. You'll want to pick the right insurance company (one that's financially sturdy and won't hassle your loved ones over a claim), the right type of life insurance (term, whole or a hybrid), and the right dollar amount. Experts say you should take the following steps before signing up for a policy:

• Check up on the life insurance company. Even a well-known insurance company may be financially weak or have unsatisfied customers. To find the strongest, most reliable life insurance companies, look at their financial-strength ratings (as reported by the five major rating agencies: Standard & Poor's, Moody's, Weiss, Fitch Ratings and A.M. Best) and check for customer complaints (at the Better Business Bureau, the National Association of Insurance Commissioners and other sources). See the Useful Links and Our Sources sections in this report.

• Decide which type of life insurance you need. For most people, experts recommend a "term" life insurance policy -- the kind you're probably familiar with -- that stays in effect for a set period of time (say, 20 years) and pays your survivors if you die within that time. "Permanent" life insurance policies (including universal, variable and whole-life) are investments that you can cash in before you die, Reliable sources for financial advice -- including ConsumerReports.org, SmartMoney magazine and CNNMoney.com -- don't recommend these costlier policies for most people. See our discussion on term life insurance versus permanent life (below) for more.

• Make life insurance companies compete for your business. It pays to shop around: If you can save just $5 per month on your life insurance premium, that adds up to $1,200 for a 20-year term life insurance policy. Once you have a short list of good companies to consider, get preliminary insurance quotes from all of them. You can also check with an independent agent who represents several companies to see whether one of the companies will match or beat a certain price. You can also type your information once into an online rate-comparison site (such as Netquote.com, Insure.com, Insweb.com or Insurance.com) and automatically get quotes from several major insurance companies, although not all companies work with these sites.

How much life insurance do you need?

One rule of thumb is that you need life insurance totaling five to seven times your annual salary. Once you factor in college tuition, mortgage payments and more, the number can balloon quickly. "For a lot of working people with children and a stay-at-home spouse, the very least amount of life insurance they should have is $1 million," fee-only financial planner Mary Dean tells ConsumerReports.org. But experts say it's better to sit down and figure out how much your family would really need: "Buy only enough so that your loved ones don't suffer financially, not enough to make them feel like they've hit the lottery," says Jack Hough at SmartMoney magazine.

If you'd like help from a financial planner, ConsumerReports.org and SmartMoney magazine recommend hiring fee-only planners who charge a fee for their services -- they don't earn commissions by selling you insurance. Find one at the National Association of Personal Financial Advisors' website, napfa.org. Or try the quick life insurance calculators at the American Institute of CPAs' website and Bankrate.com, which allow you to factor in things like college costs and mortgage payments; see Useful Links.

When should you buy life insurance?

The best advice is, if you can, buy life insurance when you're healthy. Healthy people enjoy the cheapest life insurance rates. "If you take heart medication or are grossly overweight, you may pay 50 percent more than preferred rates," says CNNMoney.com. "If you smoke, have a risky occupation, or engage in risky sports like skydiving, you'll pay even more for life insurance." In cases like these, a good agent can really help you shop around for the best life insurance policy.

Otherwise, buy life insurance when you're young and healthy -- but not until you have dependents. If necessary, "get serious about your health and move up to a better risk class," says ConsumerReports.org. Lose extra pounds. If you have high cholesterol or high blood pressure, lowering those "could knock off tens of thousands from your premiums over the life of the policy." And for the biggest savings? Quit smoking.

What type of life insurance do you need?

When you're shopping for life insurance, you'll have a choice between two major types:

Term life insurance

• Term life insurance is the most familiar type. You buy a policy for a set term -- say, 20 years -- and pay a premium every year. If you die during that time, the insurance company pays your beneficiary the amount of the policy.

• Return-of-premium life insurance is a related type. If you survive the term of your life insurance, you get back every dollar you paid in premiums. It's cheaper than permanent life insurance, but not as cheap as term life insurance -- and as SmartMoney magazine points out, "You could likely do better (investing) on your own. A zero-percent return on your investment is no great shakes."

Permanent life insurance

Permanent life insurance includes a few subtypes. This type of life insurance is actually an investment account that you can leave untouched until you die or cash in before you die.

• Whole life insurance lasts for your entire life (unlike term life, which lasts only for a fixed number of years). You can lock in your rate so your premiums never change, and you may be able to borrow money on your policy -- but you must keep paying the premiums regularly.

• Universal life insurance policies are similar, but more flexible -- you can defer premiums, if necessary -- but universal life can have higher fees than whole life.

• Variable life insurance charges higher fees, but it also usually offers a wider variety of investment options (such as stock funds).

You'll also run into some hybrid types, such as variable-universal life insurance, combination life insurance (which combines term and whole life features) and survivorship life insurance (which covers two people with one policy, paying after both die).

So which should you buy? For most people, stick with term life insurance, advise experts including ConsumerReports.org, CNNMoney.com and SmartMoney magazine. It's usually much cheaper. "For example, a 49-year-old male California resident in top health can get a $1 million term life policy for level monthly premiums of about $160, while the same coverage from a whole life policy would cost about $760," says ConsumerReports.org.

You might feel like you're wasting money with term life insurance -- indeed, if you don't die during the term, you've spent thousands of dollars in premiums to get nothing -- but experts say term life is still a better deal because you can take the money you save on term life's cheaper premiums and invest it any way you want. "You can most likely do better saving for retirement on your own," says SmartMoney magazine. "Whole life policies are notorious for having higher fees and administrative costs than other investment vehicles. … Resist pitches from brokers who might tell you that a whole life policy can substitute for a 401(k) or IRA. It won't."

In fact, investment-type life insurance policies can cost so much more that buyers "often can't afford an adequate face value, leaving themselves underinsured," says CNNMoney.com.

Finally, although whole-life insurance policies guarantee a minimum payout, remember that the possible returns your agent quotes you over and above that "are simply guesses -- not reality," says CNNMoney.com. ConsumerReports.org says, "In many cases, the investment returns are neither transparent nor reliable," and "insurers often overstate the rates of return promised."

Besides, "it's a relatively rare family that needs insurance for their entire life," says Kathy Kristof of CBSMoneyWatch.com. For example, you can buy a 20-year term life insurance policy when your kids are young that will cover you until they get out of college, or a 30-year policy to protect your spouse until you retire. Whole-life insurance policies that last beyond that are "generally good for people who have an unusual situation -- a family business, a disabled child or some other unique situation that demands economic support for heirs forever," Kristof says. "Everyone else should buy term."