Every week in March, we’ll post on how much insurance you may need. While this question can challenge and confuse even the most financially savvy individuals, planning ahead is the best way to provide the peace of mind and support your family needs. It allows you to stay confident and powerful over your future, regardless of what life brings.
Today we’re focusing on life insurance. While most families are aware of their need for life insurance, few have the confidence of knowing they have the right coverage.
Who needs it?
Life insurance replaces lost income and support after death. This allows a family to avoid a dramatic change of lifestyle. Life insurance is important for breadwinners, caregivers, stay-at-home moms, and anyone else responsible for the care of others.
A second major use of life insurance is for estate taxes and other expenses due at passing, such as funeral costs and mortgages. For high net worth individuals, life insurance can also offset any taxes on their estate.
There are also business reasons to purchase life insurance. A key-man policy may provide income to a company should they lose a key employee. A buy-sell agreement may specify that the company or other business partners own insurance on each other to provide the funds to buy out a deceased partner and provide for his or her family.
What options are available?
The major types of life insurance are term, whole, universal and variable. Term life insurance provides an insurance benefit for a fixed period, such as 10, 20, or 30 years. The premiums are fixed. After the term, however, there is no further life insurance benefit. Because of the limited benefit, term life insurance is usually the cheapest option. Term life insurance is most often used for temporary life insurance needs, such as a breadwinner during his or her working years.
The next type of insurance is whole life insurance. Unlike term life insurance, whole life insurance provides a death benefit that lasts for the insured’s lifetime. The premiums may be fixed for a certain period, such as 20 years or until age 65, or may continue through life. Whole life insurance provides a fixed death benefit and charges fixed premiums. It also provides a buildup of investment value called the cash value which can be borrowed against as a source of income. This cash value grows at a guaranteed rate determined by the insurance company. Whole life insurance is most often used for permanent insurance needs, such as estate taxes. Because there is a cash value that can be accessed during life, it can also be used for retirement income during market downturns.
Universal and variable life insurance are similar to whole life insurance by providing a life insurance benefit that lasts for the insured’s entire life. Unlike the fixed benefits and premiums of whole life insurance, however, universal and variable life insurance provide much more flexibility. Universal life insurance allows for premium payments that change year after year. In return, however, the cash value isn’t guaranteed and may eventually require an unexpectedly large premium to keep the policy from lapsing. Universal life insurance is often used by individuals whose income varies year by year, such as salespeople or entrepreneurs.
Variable life insurance takes a step further by investing the cash value in investment portfolios. Some also allow for variable premium payments like universal life insurance. While the insured can earn a higher rate of return, there is also more risk and fewer guarantees. Instead of the insurance company guaranteeing a fixed return, the insured is responsible for choosing investments which may turn south.
How much do I need?
There are many factors in determining how much life insurance you need. The first is how much income your family will lose. This depends on your yearly earnings and the length of time you plan to continue working. A 30-year-old has a higher insurance need than a 60-year-old a few years out from retirement. Also, consider any other sources of income outside of your salary. This would include a spouse’s income, rental income, royalties, and dividends. All of this income can help your family pay the bills.
The next major factor is other liquid assets, such as savings accounts, CDs, and investment portfolios. Your family could draw from these savings to meet their expenses. On the other hand, if you have relatively low savings, life insurance is even more important.
You also need to consider your family’s other expenses. If you have young children, would they need to attend daycare as your spouse goes back to work or increases his or her hours? Are you planning to send your children to college, and do you have savings to cover this expense? Do you have a mortgage, student loans, or other debt that you’d like to pay off to give your family peace of mind? Would you like to support your parents as they age? Life insurance can allow your family to carry out your wishes without a financial burden.