Life Insurance is a simple answer to a very difficult question: How will my family manage financially when I die? It’s a subject no one really wants to think about. But if someone depends on you financially, it’s one you cannot avoid.
There are many types of life insurance, but for all of them the bottom line is he same: They pay cash to your family after you die, allowing loved ones to remain financially secure. Life insurance payments can be used to cover daily living expenses, mortgage payments, outstanding loans, college tuition and other essential expenses, And, importantly, the death-benefit proceeds of a life insurance policy are almost never subject to federal income taxes.
If you’ve worked hard to establish a solid financial framework for your family – investments, home equity, a savings plan, retirement accounts – life insurance is the foundation upon which all of it rests. It can guard against the need for your loved ones to make drastic changes to future plans when you die. Certain types of life insurance even have a built-in cash accumulation feature that can help you reach savings goals.
Most Americans need life insurance, and many who already have it may need to update their coverage.
Insuring the times of your life
If someone depends on you financially, you probably need life insurance. Here are some examples of specific life stages or life events that might trigger the need for life insurance.
Married or Getting Married
Many families depend on two incomes to make ends meet. If you died suddenly, would your spouse have enough money to cover funeral costs, credit card balances, outstanding loans and daily living expenses?
A Parent or About to Become One
Raising a child is one of the most rewarding things a person can do in life. But it’s also one of the most expensive. If you died tomorrow, would your spouse have the wherewithal to provide your children with the opportunities you always dreamed they’d have? From diapers to diplomas, would there be enough income to pay for daycare, a college education and everything in between? Even parents who don’t work outside the home need life insurance because they provide services that would be expensive to replace, such as childcare, transportation and managing the household. And what about single parents? They need life insurance more than anyone because their children rely on them for everything.
If you’re like most people, your home is your most significant financial asset. Life insurance can be used to pay down or retire the mortgage, sparing your family from moving to a less expensive place to live. Plus, it can provide the funds needed to help family members maintain the lifestyle to which they’re accustomed.
If you’ve recently been promoted or changed jobs, it’s a good time to re-evaluate your life insurance coverage. Why? You may not realize it, but when your income rises, your spending tends to rise, too. Updating your life insurance coverage can help ensure that your family would be able to maintain its new and improved lifestyle if something were to happen to you.
Retired or Planning for Retirement
If your children are on their own and your mortgage is paid off, you might feel your need for life insurance has passed. But if you died today, your spouse could outlive you by 10, 20 or 30 years. Would your spouse have to make drastic lifestyle adjustments to make ends meet? Adequate life insurance coverage can help widows and widowers avoid financial struggles in retirement.
Most single people don’t have a pressing need for life insurance because no one depends on them financially. But there are exceptions. If you’re providing financial support for aging parents or siblings, or if you’re carrying significant debt you wouldn’t want passed on to family members, you should consider life insurance.
How much do you need?
The most important part of buying life insurance is determining how much you need. Since everyone’s financial circumstances and goals are different, there is no rule of thumb to tell you how much to buy.
But do you really need $250,000, $500,000, $1 million or more? Sounds like a lot of money, but imagine if one of those amounts had to pay for a funeral, retire credit card balances and other debts, and support your loved ones for years to come. Would it be enough? How would you know?
To start, estimate what your family members would need after you’re gone to meet immediate, ongoing, and future financial obligations. Then, add up the resources your surviving family members could draw on to support themselves. These would include things like a spouse’s income, accumulated savings, life insurance you may already own, etc. The difference between the two is your need for additional life insurance (see below).
This mathematical equation may seem simple enough, but coming up with all the inputs can get tricky. Plus, you’ll need to factor in the effects of inflation and assumptions about how much your investments will earn over the long run.
What kind should you buy?
The most basic feature of a life insurance policy is the death benefit; the lump-sum payment your beneficiaries would receive if you were to die. It’s the core reason to own life insurance-but not the only one. Some types of life insurance offer other features that can play an important role in your financial strategy, such as the ability to accumulate cash value that gorws over time.
Term life insurance provides protection for a specific period of time – the “term” – and is designed for temporary circumstances. It makes the most sense when your need for coverage will disappear at some point, such as when your children graduate from college or when debt is paid off. The most common term policies provide coverage for 20 years, but they can run the gamut from one-year policies to terms of 30 years or even longer. Typically, term insurance offers the greatest amount of coverage for the lowest initial premium and is a good choice for young families on a tight budget.
Permanent insurance offers lifelong protection, and you can accumulate cash value on a tax-deferred basis. This cash account can be used for a variety or purposes, from helping you out of a tight financial spot, to provide funds to take advantage of an opportunity to supplementing your retirement income. The downside? Initial premiums are considerably higher than what you would pay for a term policy with the same face amount. Permanent insurance falls into four categories.
Whole Life is the simplest and most common option. Premiums remain the same for life, and the death benefit and rate of return on your cash value are guaranteed.
Variable Life, you can seek potentially better returns by allocating your fixed premiums among investment sub-accounts, typically comprised pf stocks and bonds.
Universal Life offers the flexibility of varying the amount of your premium payments. It also offers the certainty of guaranteed minimum death benefit as long as your premiums are sufficient to sustain it. If you do not maintain those minimum premiums, your death benefit can be reduced.
Variable Universal Life premium payments are also adjustable, subject to the minimum needed to keep the policy in force, and you can allocate them among investment sub-accounts that offer varying degrees of risk and reward.