Insurance policies typically come with a deductible -- an amount you must pay before your coverage kicks in. For example, if you have a $500 deductible on your homeowners insurance and a tree falls on your house requiring repairs, you'd pay $500 of the cost, and the insurer would pay any additional expenses for covered repairs up to policy limits.
With some types of policies, such as home and auto insurance, you usually can set your deductible. For other policies, such as health insurance, the deductible is fixed, so you'd need to pick a policy with a deductible you can afford.
Since you're responsible for the deductible when you need covered services, it's important you always consider how much of a deductible is right for you. Here are some tips to decide:
1. Understand the relationship between deductibles and premiums
While most people would naturally like a lower deductible because that means paying less money out of pocket if a problem arises, lower deductibles come at an added cost. If you reduce the deductible on your insurance, or if you pick a health insurance policy with a lower deductible, premiums tend to be higher. Premiums, or the monthly cost you pay for a policy, are fixed and predictable costs you have to pay to stay covered regardless of whether you end up making an insurance claim or not.
Some people would prefer to pay higher premiums all the time for the peace of mind that comes with knowing they don't have to pay much out of pocket when a problem arises. But this isn't always the right choice. For example, if raising your auto insurance deductible from $500 to $1,000 would save you about 10% in premium costs, and you're currently paying $900 per year for car insurance, you'd likely save around $90 annually by raising your deductible.
If you put this money into a savings account, you'd be able to save up the extra $500 to cover the higher deductible in about 5 1/2 years. If you didn't get into a car accident in that time, you'd be better off. You could keep that money saved in case of an accident and continue to benefit from paying $90 less each year for insurance. Of course, if you did have a collision during those 5 1/2 years and had to pay $500 for repairs, you'd end up worse off with larger total out-of-pocket costs than if you'd paid for the more expensive policy.
2. Consider the likelihood you'll need to make an insurance claim
With some types of insurance, you can't really predict when you're going to need to make an insurance claim. It's hard to know, for example, when your car might be stolen or if someone might break into your house next year. But when buying health insurance, there are times when you'll know if you're going to need more coverage.
If you're going to have a baby next year, if you have a chronic condition that requires regular doctor visits, or if you have an operation planned, then you know you're going to use your insurance. If that's the case, you'll probably benefit from getting a policy with a lower deductible. But if you have no medical issues, are young and healthy, and almost never go to the doctor, you may decide to gamble on a policy with a higher deductible and lower premiums under the assumption you probably won't actually need your insurer to pay for much care.
3. Know what's covered outside of the deductible
With some policies, you get full coverage for certain types of services before you've met your deductible. With car insurance, for example, you may be able to get your windshield repaired without incurring any costs, even if your deductible for collision or liability coverage hasn't been met. With health insurance, you can usually get preventive care and screening at no cost even if you haven't yet met your deductible.
Knowing what coverage you have before meeting the deductible will help you to assess the likelihood you'll need to pay out of pocket for services.
4. Assess your savings rate to make sure you can cover your deductible
Be sure you have the money available to cover your deductible if something happens. If you have a $2,000 deductible and have $2,000 in an emergency fund or in a health savings account, you don't need to worry much if you must go to the doctor or if something happens to your car or house. But if you have $0 saved, you could be in trouble if you end up covering a hefty deductible -- especially as you usually need to come up with the money right away if you get sick or your car or house needs repairs.
If you'd end up relying on high-interest debt to cover costs with a high deductible policy, you may be better off paying a little more for premiums so you don't have to worry about this happening. You can then work on saving to cover your deductible and change your policy once you have the extra cash in the bank for what you need if something goes wrong.
5. Don't get the wrong insurance coverage
Insurance is supposed to protect you from unexpected costs and ensure you can cover essential expenses when something goes wrong. Now you know how to adjust your deductibles so you can fully benefit from this protection without spending for coverage you don't really need. The key: Find a policy that's a good fit.
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