Life insurance is one of the most important purchases you’ll ever make. In the event of a tragedy, life insurance proceeds can help pay the bills, continue a family business, finance future needs such as your children’s education, protect your spouse’s retirement plans, and much more. It is the foundation for your financial legacy.
How Much Life Insurance Do I Need?
Determining the amount of life insurance you need is not a precise process. It is based more on your ideal financial legacy. Ask yourself: How much money will my family need to maintain their standard of living over the long run? If you have dependents, the rule of thumb is you will need 12-14x your income to replace your financial stream.
Life insurance proceeds can help pay immediate expenses including uncovered medical costs, funeral expenses, final estate settlement costs, taxes and other lump-sum obligations such as outstanding debts and mortgage balances. They can also help your family cover future financial obligations like everyday living expenses, money for college or your spouse’s retirement, and so much more.
Human Life Value
When thinking about life insurance, it is important to consider your human life value. Your human life value is your economic worth over the course of your lifetime. This is important as this is the amount of income you are projected to earn that you and your family count on.
Sometimes you hear about human life value in the case of a wrongful death lawsuit. Someone is killed prematurely and their human life value is calculated to determine the economic loss to their survivors.
If you were to calculate your human life value, the number may astonish you.
Protect your loved ones by purchasing life insurance.
Capital Needs Analysis
The most common way to determine your life insurance needs is by conducting what’s called a Capital Needs Analysis. Here’s how it works:
- Evaluate your family’s needs.
Gather all of your personal financial information and estimate what your each of your family members would need to meet current and future financial obligations.
- Tally up resources.
Assess all of the resources that your surviving family members could draw upon to support themselves.
- Calculate the difference.
The difference between their needs and the resources in place to meet those needs is your need for additional life insurance.
This may look simple enough, but calculating one’s life insurance needs can actually get pretty complicated.
Who Needs Life Insurance?
Get Life Insurance While You are Young and Single
If you’re young, healthy and have a good family health history, your insurability is at its peak and you’ll be rewarded with the best rates on life insurance. If you anticipate a need for life insurance down the road (e.g., you’re the marrying type) and you can fit the premiums into your budget, it might make sense to lock in coverage while you’re young and single. Doing so can eliminate the worry of having to qualify for coverage when you’re older and maybe not as healthy as you once were.
Furthermore, you may have people that depend on you financially. For instance, some single people provide financial support for aging parents or siblings. Others may be carrying significant debt that they wouldn’t want to pass on to family members who survive them.
Reconsider Your Life Insurance Policy at Major Life Events
If you have someone who is dependent on your income, you may be a candidate for life insurance. Additionally, there are several life events that may trigger a life insurance need:
- Getting Married
When you’re married, you share everything with your significant other, including your financial obligations. Many people mistakenly believe that they don’t need to think about life insurance until they have children. Not true. What it one of you were to die tomorrow? Would the surviving spouse be able to pay off credit-card balances and car loans, or cover the monthly rent and utility bills? If you’re planning to have children, you’ll want to buy life insurance right away and not wait until the mom-to-be is pregnant. Some companies won’t issue a policy to a woman during her pregnancy. Since health complications sometimes arise, they’ll want to wait until after the baby is born to issue the policy. Buying insurance before a baby is on the way helps avoid this potential problem.
- Having a Child
Most families depend on two incomes to make ends meet. If you died suddenly, could your family maintain their standard of living on your spouse’s income alone? Probably not. Life insurance makes sure that your plans for the future don’t die when you do.
- Divorcing or Becoming a Single Parent
As a single parent, you’re the caregiver, breadwinner, cook, chauffeur, and so much more. Yet nearly four in ten single parents have no life insurance whatsoever, and many with coverage say they need more than they have. With so much responsibility resting on your shoulders, you need to make doubly sure that you have enough life insurance to safeguard your children’s financial future.
- Buying a Home
When you buy a home, you take on a mortgage obligation that must be paid back, even at death.
- Opening a Small Business
Besides taking care of your family, life insurance can also protect you as a small business owner and your business. What would happen to your business if you, one of your fellow owners, or perhaps a key employee, died tomorrow? Learn more about business options such as key person insurance.
- Changing Jobs
If you have changed jobs, you may have lost some of your life insurance benefits. It is important to reassess your needs to ensure you are adequately covered.
- Grown Children
Just because the kids are through college and the mortgage is paid off doesn’t necessarily mean that Social Security and your savings will take care of whatever lies ahead. If you died today, your spouse will still be faced with daily living expenses. Would your financial plan, without life insurance, enable your spouse to maintain the lifestyle you worked so hard to achieve?
Depending on the size of your estate, your heirs could be hit with a large estate tax payment after you die (45% of your estate)? The proceeds of a life insurance policy are payable immediately, allowing heirs to take care of estate taxes, funeral costs, and other debts without having to hastily liquidate other assets. And life insurance proceeds are generally income tax free and can be arranged to avoid probate. Finally, if your insurance program is properly structured, the proceeds from your life insurance policy won’t add to your estate tax liability.
Types of Life Insurance
Term Life Insurance
Term life insurance is the most common type of life insurance. The rates are locked in for a specified period of time. Typically 10, 15, 20 and 30 years.
Pros of term insurance:
- Can obtain a large amount of benefit for least amount of cost.
- Rates can be locked in for a fixed period of time.
- Policies can be converted to a permanent policy without any medical underwriting.
Cons of term insurance:
- Policy expires at the end of the term.
- Policy is inflexible. You may not reduce or increase death benefit.
- Death benefit does not increase with inflation.
- At the end of the term, premiums can be significantly more expensive as age increases and if an adverse change of health has occurred.
Some term life insurance has a provision, or rider, which is an option that gives the owner the right to change to a plan of permanent insurance without providing evidence of insurability. The policy will define the time period in which a conversion may be exercised; it may be limited to a number of years after policy issue, such as 5 or 10 years, or to a certain age, such as age 65. This time limitation is to minimize adverse selection, which is always present in term renewals and conversions. Those policyowners in poor health at the time of renewal, or as the conversion period ends, are more likely to use these policy provisions and pay a higher premium than those who are in good health or otherwise insurable.
The conversion may be on an attained age (current) or original age (or retroactive) basis. The premium rate of an attained age conversion, the most common type, is based on the insured’s age at the time of conversion. Original age conversions allow the new policy to be issued at the age of the originally issued term policy.
Universal Life Insurance
Universal life insurance is a permanent type of life insurance that provides flexibility. It is typically more expensive than a term policy but less expensive than a whole life policy.
Pros of universal life insurance:
- Rate can be locked in for life.
- Policy is flexible. Death benefit may be reduced at any time.
- Additional premium can be paid into policy to accumulate more cash value.
- Cash accumulates on a tax-free basis.
- Premiums are adjustable within a minimum and maximum range.
- Cash accumulates based on interest rates
- Less expensive than whole life.
Cons of universal life:
- More expensive than term insurance.
- If cash does not accumulate and only minimum premiums are paid, an increase in premium may be required to keep the policy in force.
Whole Life Insurance
Whole life insurance is a permanent life insurance policy. It is the most expensive type of permanent insurance, but can accumulate the most cash value with the highest guarantee rates.
Pros of whole life insurance:
- Rates are guaranteed for life.
- Policy accumulates cash value by receiving company dividends.
- Death benefit increases over time with paid up additions.
- Cash accumulates on a tax free basis.
- Guaranteed rates of return.
Cons of whole life insurance:
- Most expensive option.
- Premiums must be paid regularly.
- Policy is inflexible.
Juvenile Life Insurance
Life insurance for your child is a gift in their future. The main purpose of purchasing a life insurance policy for a child is not the death benefit. It is to protect their insurability. While your child is young and healthy, he can qualify for coverage and add increase options that can be purchased in the future without further medical underwriting.
Consider this example: Several years ago, a set of new parents purchased a life insurance policy on their healthy, newborn son. It was a relatively small policy for $100,000 death benefit and a premium of $30/month. At the age of 7, he was diagnosed with Type 1 diabetes. As a result, this child will have a difficult time purchasing a policy in adulthood without paying substantially higher premiums. However, the policy has future purchase options which will allow him to purchase additional death benefit amount without any medical questions at certain ages (18, 21, 25, 28, 30) or at a life event (marriage, birth of a child).
Juvenile policies tend to be significantly less expensive than adult policies and there is very little medical underwriting. Therefore, it can make a special gift, especially if there is an adverse change in health. Furthermore, the policy accumulates cash on a tax favored basis that is available to the child at a later date.
For more information about life insurance, contact Set for Life Insurance today!