Life insurance can help provide for your spouse and your children if you were to pass away unexpectedly. Proper life insurance coverage should provide peace of mind, since you know that those you care about will be financially protected after you die.
Why do I need life insurance?
If you died today, would your spouse have enough money to pay the bills without selling your home or other assets, or borrowing money? Could your spouse maintain your current standard of living, send your kids to college and retire comfortably?
Life insurance provides cash benefits, generally free of income tax, which could help your family avoid difficult or costly choices. Cash can help pay off debt, build a college fund, or provide a nest egg for your children. Furthermore, life insurance can replace lost income that can maintain your family’s standard of living after your death. Your lifetime earning potential is probably the single biggest asset you own. By replacing your income if you die prematurely, or before enough assets have been accumulated to satisfy your financial goals, life insurance can be the ultimate safety net.
HOW MUCH COVERAGE DO YOU NEED?
A commonly used rule of thumb is to purchase life insurance benefits equal to 10 times gross income. Another option is to calculate what your dependents would have if you were to die now, and what they would actually need. Your new policy should come as close to making up the difference as you can afford.
In figuring what you have, count your present insurance, Social Security benefits, savings, investments and real estate. If you have stock options, check to see if your stock grants would automatically vest upon death.
In figuring what you need, consider the following:
- Pay off mortgage— Consider whether your family would want to pay off your mortgage with life insurance proceeds. Doing this eliminates a large monthly expense.
- Pay off other debt— After the mortgage, there may be other sizeable debts that should also be cleared, like car loans, student loans, etc.
- Set aside college costs— Using life insurance proceeds to fund college expenses frees your surviving spouse from the worry about how they are going to pay for this big ticket item.
- Set aside living expenses— Part of the proceeds can be used to cover current and future living expenses. How much do you spend each month? How much do you save each month? You can adjust the amount needed, depending on variables such as your spouse’s current or future income, how long he or she needs the income and so on.
- Fund final expenses— Your family may bear the burden of expensive funeral costs or medical bills.
Types of Life Insurance
Life insurance policies come in two basic categories, term and permanent.
Term life insurance provides coverage for a specific period, often 10, 15 or 20 years, and is generally less expensive. If you die during the coverage period, your beneficiary receives the policy death benefit. If you live to the end of the term, the policy simply terminates. Term coverage is designed to protect your family from the loss of your income.
Permanent life insurance provides coverage as long as you live, which makes it more useful for estate planning. Premium payments are higher than term policies as the premium covers the life insurance benefit and builds a cash reserve. Should you discontinue the policy, this reserve, known as the cash value, is returned to you, subject to surrender charges. Permanent life insurance policies come in two categories: whole and universal.
Whole life: The premium amount is generally level (equal) for life. The death benefit and minimum cash value are predetermined and guaranteed.
Universal life: The premium amount is flexible, the death benefit is generally not guaranteed and the cash value will grow at a declared interest rate less policy expenses, which may vary over time. A Variable Universal life policy includes an investment component, where the death benefit fluctuates based on the value of the underlying investments chosen. These types of life insurance policies may not be optimal to protect your family from the loss of your income because of these uncertainties.
Where Can You Buy Life Insurance?
You can purchase insurance coverage through a group life insurance plan offered by your employer or through an association to which you belong. Keep in mind, you may not be able to retain this coverage once you leave your employer. Alternatively, you can buy insurance through a licensed life insurance agent or broker, or directly from an insurance company. We recommend working with an independent agent who can help evaluate your needs and suggest the optimal insurance solution and policy provider.
Life insurance is a valuable tool to protect your loved ones. It plays an important role in your long-term financial plan, along with property and casualty insurance to protect your assets, and disability insurance to protect your income in the event of an accident or illness. If you have questions about insurance strategies, your Paracle advisor can help you review your options and refer you to insurance specialists.
We’d like to thank Hoon Kang of Elliott Bay Insurance Advisors for contributing to this article.