The need for life insurance can be a complicated and sometimes confusing decision. There are dozens of variables that may factor into your need for coverage. The details of your personal situation are different than just about everyone else who is asking the same question. In this post, I’ll introduce a basic framework for reviewing your family finances to help decide if you need life insurance and how much may be necessary.
We have three learning objectives for this post:
To know the difference between the basic types of life insurance
To be able to determine your need for life insurance
To understand how to determine the amount of life insurance you need
All life insurance generally falls into two categories: Cash value policies (also known as “permanent”) and term policies. Term polices are pure life insurance. These are issued for a particular period of time, usually 10, 20 or 30 years and then the policy expires even if you are still alive. This is the most inexpensive type of policy since you are only paying for the insurance. Term policies do not accumulate any cash value so the death benefit is the only payout possible, assuming you die before the term is up.
There are several different types of cash value policies. Common names for these permanent policies are “whole life”, “universal life”, “variable life” and indexed “universal life”. These polices provide a death benefit, just like term life does, but they also include a savings or investment program where part of your premium payment is placed in an accumulation account where it will earn interest or be invested in mutual fund-like vehicles that may grow in value over time. Obviously, the premium payments are higher than term policies at a particular age because part of the payment is put into the investment aspect.
Determining the need for insurance should be based on facts, not emotions. Buying a policy on a family member’s life because you love them may not be a good financial decision. The real purchase of insurance is to account for lost income or to satisfy outstanding financial obligations in the event of your death or that of your spouse.
For example, in most cases single individuals do not have a need for life insurance unless they are responsible for taking care of a child or dependent adult. The death of a single person upon which no one else relies financially, while tragic, does not create a financial need that requires coverage by life insurance. However, one reason a person may want to buy insurance while younger and single is that they intend to be married and have children one day and want to lock in a lower premium for their policy. Life insurance premiums for new policies rise for each year you get older in an accelerating manner, especially as you get to age 60.
Next example, Rob and Sue are married couple in their 30s with two children, ages 4 & 6. Rob works as the sole breadwinner and Sue works in the home raising the kids. They have a 15-year mortgage on their home of $300,000 and intend to pay for college after the kids graduate high school. This is a more complex situation which could be handled by one large cash value policy, or perhaps a combination of cash value and term policies. Remember, term policies are in effect for a certain amount of time and can be matched against obligations that are finite in the time they will exist.
In this second example, the risk of the mortgage debt could be taken care of by the Rob purchasing a “decreasing term policy”. These are the cheapest possible policies because the death benefit declines each year until it reaches zero when the policy expires. Because mortgage balances decline to zero at the end of the payments, decreasing term policies can be aligned with the mortgage term. A standard 20-year level-term policy would work well for making sure the children’s college expenses were covered in the event of the Rob’s untimely death. Once the kids graduate from college, the expense of tuition disappears and no longer represents a life insurance need.
The last part of this life insurance plan would be to put in place a cash value insurance policy, which would leave Sue a lump sum of cash large enough to be invested and create income for her to live on in her husband’s absence. Note that the best plan is to use the income the life insurance benefit creates once invested, not use the death benefit itself as income. Of course, if Sue were likely to reenter the workforce after her children are at college, it would lessen the amount of life insurance that would be necessary.
As you can see from our two examples, every family situation is different. There are several concepts used to calculate the amount of insurance needed. Some of these are simple, like buying 10 times the amount of your annual income, to more detailed calculations that account for your personal financial situation. The websites linked below will be helpful in reviewing your situation and your insurance need.
Important Tip – I suggest not going to general websites that promote life insurance quotes. Most of these sites require you to input information like your telephone number and email along with answering some other questions. Once you submit, you will likely be swamped with phone calls and emails from insurance sales people (literally dozens!). Rather, I suggest going to a local agent on a referral from someone you know or dealing directly with a particular insurance company or agency.
Integra Capital Advisors is a member of the DPL Financial Network where our clients can access no-commission or low-commission insurance policies of different type including life insurance. We can help calculate your life insurance need and help you obtain the appropriate insurance at the best cost. Call us at 941-778-1900 or Click Here to contact us today.