Most of us don’t like vegetables this much, even though we know they are good for us. The same goes for insurance. It’s not fun, glamorous, or sexy, but we do need it to build a healthy financial platform for future investing.
Life insurance is a way to protect those who depend on your paycheck against possible financial trouble in the event of your death. If you die prematurely, life insurance can provide ongoing income to your dependents, until they are able to live comfortably without it. It can also provide emergency support for legal, medical and funeral costs, should family savings not be enough to cover them.
Life insurance can do a number of great things especially during the worst of times. The problem is, many people are confused about the options available or don't realize the importance until it's too late. They may put off the decision to purchase because it's kind of morbid to think about.
Understanding life insurance can be easier than you think. To help make sense of it all, here’s a quick refresher on the subject that will provide a basic understanding of the options available and why they’re important to you.
How Much Is Enough
There are a number of factors to consider when determining the appropriate amount of life insurance to purchase. Are you single or married? Do you have any dependents? What is your annual household income and how much longer do you plan to work? These are just a few important questions that must be addressed in order to be sure that you are purchasing an adequate amount of coverage.
With life insurance, you don't want to be under-insured or over-insured. Being under-insured means there will not be enough money left for your family in the event of your death. Being over-insuring is essentially having more coverage than is necessary, causing you to pay higher premiums along the way.
You may have heard of several ways to calculate amount of life insurance you may need. Some of these include four times your salary, ten times your salary, your salary times the number of years left until you retire. I’m a fan of calculating insurance based on your needs. Here’s an example:
Let’s say you have an annual salary of $50,000 that you expect to continue receiving over the next twenty years. You’ve calculated that your burial costs will run around $15,000. You currently have $17,000 in outstanding debt and you make an annual charitable contribution of $12,000. There’s also a beach house that you inherited, and the taxes and upkeep cost around $5,000 per year. In your scenario, you would calculate the following.
Annual Salary for 20 Years: $1,000,000 (well, we didn't include inflation for this example)
Final burial costs: $15,000
Loan Payoff amounts: $17,000
Gifts to charity: $240,000
Other needs: $100,000
Total Coverage: $1,372,000
In this example, if you had used four or ten times your salary, you would have been woefully under-insured to cover your expenses with a policy of $500K. Even if you had 20 years until retirement, you would have come up short using that as an estimate.
What Type of Insurance Do I Need?
With the myriad of insurance products available on the market, many people don't understand what type of policy they need, when they should buy it or even why they need life insurance in the first place.
Although some insurance salesmen may try to convince you otherwise, there really is no one-size-fits-all-approach to life insurance (like term only). This is why, instead of making blanket recommendations for your specific situation (which would be next to impossible and careless on my part), I’m going to describe what type of life insurance might make the most sense at various stages in your life.
Before we jump in, it’s important that you understand two basic types of life insurance: term and permanent.
Term life insurance provides a guaranteed death benefit and covers you for a predetermined number of years, often somewhere between ten and thirty.
The annual premiums are a fixed amount and based on your health and life expectancy at the time you apply for the policy. Term insurance is considerably cheaper than the permanent alternative and once the term period ends, your coverage ends. If you were to pass away prior to the term period ending, then your beneficiaries receive the face value of the policy.
Permanent life insurance combines a death benefit with a savings or investment account. You may have heard of policies such as Whole Life, Variable Life, or Universal Life Insurance. These are all types of permanent life insurance. As the name implies, the policy covers you for as long as you're alive, even if that means you live to be 110. Depending on the policy that you purchase, these premiums can be fixed or variable, and similar to the term insurance, the premiums are based on your health and medical history.
One major criticism of a permanent insurance policy is that it is several times more expensive than a term policy for the same amount of coverage. Proponents of permanent life insurance tout its ability to provide some cash value through a savings/investment component as justification for the higher premium.
Although the savings growth and investment potential is an attractive feature, many with opposing views are quick to point out that you could accomplish a similar benefit by taking the money you save on buying a term policy and investing it yourself -- with far fewer restrictions than investing within the parameters of the permanent life insurance policy. While this may be true (if you can stick with the plan!) sometimes a permanent policy is the best - it all depends on your needs.
Now that we've established the basic differences between the two, let's take a look at when you should purchase life insurance and how much coverage you may need.
Young and Single
If no one depends on you financially, some experts will suggest that you probably don't need life insurance. Many companies offer one or two times your salary in life insurance as a free benefit, so this amount may be more than enough coverage for you. While your untimely death will affect a number of people close to you, it probably won't put them in a financial bind. One caveat is if you have private student loans that required a co-signer.
Upon your death, the co-signer will become fully responsible for the remaining balance of your debt. Given this case, consider purchasing a small, inexpensive policy to cover the remaining balance of your student loan debt in addition to your potential funeral and burial costs.
Getting married in and of itself doesn't mean you need to purchase life insurance. It’s typically the events that follow, like purchasing a home and having children, that indicate you need to get a policy in place.
The younger and healthier you are, the better your rates. That’s why it makes sense to get a policy in place as soon as possible. You can always go back and add-to or change a policy as you enter different life stages. But by establishing your plan early, you stand to pay significantly lower premiums and you can enjoy the peace of mind knowing that your newly-established family is in good financial shape if anything were to happen to you.
Suppose you like to go sky-diving. While this is an awesome activity, it could potentially cause problems when you are looking for insurance. During the underwriting process, the insurance agent will ask questions about your outside activities. And although you always want to remain truthful, keep in mind that your premiums may be higher as a result.
Another high-risk scenario that could affect your insurance options is working in a dangerous occupation or environment. Every insurance company evaluates high-risk jobs and activities differently, just as they do with smoking or your health. As a result, it’s not uncommon for life insurance policies for individuals with high-risk occupations to be more difficult to obtain and include higher premiums.
As a new parent, you should have life insurance. What could happen if you or your spouse passes away unexpectedly? The surviving spouse will bear the brunt of not only the financial burden of the household expenses, but also caring for the children.
At this life stage, you will want to establish a policy that will not only pay for at least 18 years of child-rearing expenses, but also household expenses that will allow your family to maintain the same standard of living. And don’t forget to insure a stay-at-home parent. They add a tremendous amount of value that you can't put a price on.
If you already have life insurance in place, be sure to re-evaluate your policy because there might be a need to purchase additional coverage.
The Bottom Line
We never like to think about the inevitable loss of a loved one, or our family unit without our presence. But fortunately, life insurance provides our family with a level of safety so they will know the finances are taken care of, no matter what else happens. Even if you don’t like to think about insurance, it’s good for you to have some. Just like broccoli.
If you have questions or would like an objective opinion about your insurance needs, please contact me to schedule an appointment. There is no charge for a consultation, so you can't go wrong.
Pamela J. Horack, CFP® of Pathfinder Planning LLC provides personal financial planning advice for a simple fee to young adults and working families in North and South Carolina through group classes, one-on-one planning, and ongoing advice.