Should you use your tax refund to buy life insurance?
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Updated March 9, 2018: Buying life insurance and doing your taxes have something in common: You’ve probably been putting them both off.
When you finally get around to filing your tax return, there’s one thing on your mind: Will you owe money to the IRS, or will you get a nice, big refund? A tax refund always feels like free money, and temptation sets in. Oh how easy it is to blow it on some big purchase you’ve been pining for like a new LCD TV, an upgraded iPhone or your next vacation.
You could also be a bit more pragmatic and use it towards your savings, or for paying down credit card or student loan debt. Those are great alternatives, but if you have dependents a term life insurance policy is fundamental to your financial safety net. As we’ve discussed here, it can be worth it to secure a term life insurance policy even before paying off other debts—and in many cases because of those debts.
Based on national averages, there’s a good chance your tax refund will more than pay for your life insurance premiums every year. If you’re on a budget and you’ve been holding off taking out a policy to protect your family, try this strategy to get protection without really feeling it in your pocket.
Here are some reasons why putting your tax refund toward a life insurance policy is a smart idea:
In 2016, more than 80 percent of tax returns filed resulted in refunds back to tax filers, according to the IRS. Those due to receive refunds tend to file early, and in March 2016, there had been over $142 billion refunds issued.
The IRS notes that in the early filing season of 2015 (for the 2014 tax year), there were more than 40 million tax refunds issued, valued at $125 billion. At that time, the average tax refund was $3,120. In March 2016, the average individual refund issued was a little lower, but still came in at $3,053.
Some states are known for having the largest average tax refunds, so depending on where you live, your refund can go far when paying for life insurance premiums. Last year, these 10 states ranked highest:
New York: $2,964
New Jersey: $2,960
What explains higher tax refunds in these states above the rest in the nation? According to the 2016 report, states like Connecticut and New York boast some of the highest household incomes. New Jersey sees residents pay high property taxes, and Louisiana has its own income tax, which may contribute to higher refunds due to a separate state tax refund.
Most people seem to think life insurance is more expensive than it really is. It could be because the huge, sometimes million-dollar payouts make it easy to assume that your premiums will come at a premium.
But consumers across the board seem to have one thing in common when it comes to term life insurance: they overestimate how much a plan actually costs.
A LIMRA survey from last year revealed that Americans guessed incorrectly that a standard term life insurance policy (30 years, $250,000) cost more than double its actual price. A 2016 LifeHealthPro survey gets even more specific, citing 80 percent of consumers who misjudge the cost of life insurance. Generation X consumers incorrectly estimated the cost by 119 percent.
As for Millennials? The youngest adult demographic to buy life insurance overestimated its cost by more than 213 percent. In addition, a good portion of survey respondents weren’t familiar with what a life insurance payout can be used for, and don’t own a policy because they know very little about it.
So how much does term life insurance really cost?
Life insurance costs are affected by a number of factors, like your age, your health and lifestyle (Are you a smoker or a non-smoker?), or your family health history. Your gender and occupation may also play a role. Life insurance rates also rise as you get older.
A standard, 20-year term policy of $500,000 will cost just $20 a month for a healthy, non-smoker, 30-year-old male. That’s $240 per year. For a return of premium policy, the same policyholder will pay an average $91 per month, or just over $1,000 per year.
At those rates, the average $2,000-to-$3,000 tax refund could keep you covered in life insurance until you retire, which is probably about the length you want to keep a term life insurance policy. If you’re planning on putting your refund to good use in a policy, you should still do your research and find a plan that’s both comprehensive and affordable. Here’s how to get started:
Know the coverage you need. Life insurance isn’t all that different from other types of insurance. Put it in perspective — you wouldn’t buy more auto insurance than you need before getting behind the wheel, or for that matter, too little health insurance that doesn’t cover your needs. Follow the same principle with life insurance. Calculating how much life insurance you really need can be tricky, which is why we made this handy tool to do it for you. One additional tip is to "ladder" your life insurance: buy several policies at once that end at different points, and as each policy ends over time, you’ll still remain retain life insurance coverage while remaining locked into low rates from the time you bought your policies.
Choose term life insurance. With that notion, take a pass on whole life insurance. We’re big proponents of term life insurance, since, unlike a permanent whole policy, you’re not locked into terms that won’t suit you after a few years. Whole life insurance can be up to four times as expensive as term life insurance, so by opting for a term policy, you can make your tax refund go alot further. Apart from a cash investment component (which you can find a better alternative to by investing elsewhere), whole life insurance is unnecessary for most people. Having said that, you can learn more about the different types of life insurance here.
Shop around. One mistake life insurance shoppers make is relying on their employer’s coverage, or picking the first or second insurance carrier they find, falsely believing that buying direct from the provider will save them money. You can easily compare life insurance quotes across companies here. Once you’ve got a few quotes at hand, compare them and narrow down your options. And if you have questions, ask our experts. The best way to avoid overpaying for life insurance is understanding exactly what you need and what you’re getting.
There are lots of things to spend your tax refund on, but none will impart the peace of mind that a life insurance policy brings. The right policy can keep you and your family financially protected for years to come -- and to think that you made it possible from one year’s tax refund is more than any other purchase can say.
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