Brent Thoman | August 20, 2020
Most of us know that we need life insurance but that is often all we know. “Life insurance” is a bit of a catch-all term that encompasses a lot and sometimes the finer points are not clear. We will give you a primer on life insurance and you’ll be able to see why having life insurance is the foundation of a secure financial future for your family.
Types of Life Insurance
There are two main kinds of life insurance policies, term life, and whole life.
Term Life Insurance
Term life insurance also called pure life insurance, is meant to protect your dependents in the event of your premature death. If you have a term policy and die within the term, your
beneficiaries will receive a payout. The policy has no additional value. Terms are typically 10, 20, and 30 years and for most policies, the payout or death benefits and the cost or premium remain the same for the entirety of the term.
The length of the term should cover the number of years that you are paying the expenses, including higher education expenses, for your dependents. Ideally, the term’s end will coincide with your children being financially independent, your home being paid off, and having enough money saved and invested to see your spouse to the end of his or her life.
Whole Life Insurance
Whole life insurance provides coverage for the entirety of your life and has an investment
component called the cash value of the policy. The cash value grows in a tax-deferred account, you are not taxed on the gains during accumulation. You can borrow against the account or terminate the policy for cash. If you do not repay a loan taken against the policy with interest the death benefit is reduced. Your premium will remain the same for your entire life.
Who Needs Life Insurance
The easy answer is anyone with financial dependents but there is a bit more nuance than that. Your age and the makeup of your family are what determine the type of life insurance that is best for you.
Families with young children: A 20 or 30-year term policy will provide the death benefit required for income replacement. A 10-year term policy may be sufficient (depending on the age of the children) to cover the costs of childcare if the stay at home parent were to die prematurely.
Married with no children: If one spouse makes much more money than the other or one spouse does not work; whole life insurance can ensure that the remaining spouse can maintain the same standard of living he or she had during your life.
Single with no children: If you have no financial dependents, life insurance is not a must-have. The exception being those who have a loan with a co-signer be it a student loan or any other kind of loan. Consider buying a term policy that coincides with the term of the loan so the co-signer is not on the hook for the balance of the loan should you die before it is paid off.
Single parents: A single parent should consider term life insurance with a term that would cover their child until they reach adulthood which should include at least four years of college. If your child is 5 for example, a 20-year policy would be appropriate.
Married with adult children: Essentially, the same scenario applies to families in these situations as the married with no children families.
Retired couples: If you have enough money saved to last for the rest of your retirement, life insurance may not be necessary. If this is not the case, whole life insurance can meet the financial needs of the remaining spouse.
How Much Life Insurance Do You Need?
The old rule of thumb that was often suggested for determining how much insurance you should have is to multiply your salary by 10. If you earn $80,000 per year, that would mean an $800,000 policy. A newer rule of thumb uses the 10 times your salary rule and an additional $100,000 per child to cover college expenses.
Both rules are considered outdated now. Neither considers the individual needs of families, all of which will be different. They do not consider whatever savings and investments you may have, and they do not cover stay at home parents whose labor in the home may need to be replaced.
To get a more personalized idea of how much life insurance you should buy, there is a simple formula you can use, your financial obligations minus your liquid assets. To calculate your financial obligations: Add your yearly salary by the number of years you want to replace that income for, add the remaining balance on your mortgage, other debt, and future expenses like college and funeral costs. If you are a stay at home parent, add the cost to replace the services you provide like child-care.
From that number, subtract your liquid assets, things like your current savings and investments. The number you are left with is a good estimation of how much coverage you should have.
Cost of Life Insurance
As you would expect, the younger and healthier you are, the less expensive your premiums will be. But there are a lot of variables when it comes to the cost of life insurance. These are some of the other factors that are used to determine what your premium will be.
● Gender
● Family medical history
● Marital status
● Location
● Lifestyle
● Results of any required medical exams and tests
● Length of term
● Amount of coverage
Again, the cost varies widely but here is a ballpark.
Across all life insurance policies-including more expensive and guaranteed to pay out whole life policies, in addition to cheaper, temporary term life policies- that breaks down to $538 in premiums per year or about $44 per month.
Why You Need Life Insurance
Whole life insurance can provide an inheritance to your beneficiaries but that is not something that will be necessary or desirable for everyone nor is it the primary reason you need life insurance. Life insurance is meant to provide the following.
Money for Final Expenses
Even a no-frills funeral or burial are awfully expensive.
Today’s average funeral costs can range from $10,000 to $15,000. This will generally include basic service fees, viewing, and burial, moving the remains to a funeral home, embalming, a casket, and other preparations. The average cost of a standard funeral with cremation will fall between $6,000 and $7,000; however, these rates do not cover the costs of a cemetery, marker, monument, or other extras.
Life insurance helps cover funeral and other final expenses, so your family does not have to add financial stress to an already difficult situation.
Income Replacement
If you were to die prematurely, while you still had dependents, how would they maintain their standard of living? The death benefit from your life insurance policy is meant to replace your income so your spouse can raise your children alone, in the same manner, you were raising them together or so that your spouse could maintain his or her standard of living.
Mortgage Protection
On the list of life stressors, the death of a loved one is #1, and moving to a new home is #6. Having life insurance cannot protect your loved ones from #1 but it can protect them from #6. Life insurance can be used to pay off a mortgage so your family can stay in the home they shared with you.
Life Changes
It is not enough to have life insurance. You must have the right kind of life insurance for your situation and enough coverage to meet your family’s needs. And of course, life changes, families change.
We believe the current crisis has shown us all how important having a secure financial future is. Now is a good time to assess your current life insurance policies or buy one if it is something you have been putting off. We encourage you to take stock of your life and any changes that have occurred, marriage, a child, divorce, a medical diagnosis since you purchased, or last reviewed your current insurance coverage. We would love to have a conversation with you and your family to make sure that you have enough of the right insurance to provide the secure financial future you need.
This material was created for educational and informational purposes only and is not intended as ERISA, tax, legal, or investment advice. If you are seeking investment advice specific to your needs, such advice services must be obtained on your own separate from this educational material.
Securities and advisory services offered through LPL Financial, a registered investment advisor. Member FINRA/SIPC.
This article is intended to assist educating you about insurance generally and not to provide personal service. They may not take into account you personal characteristics such as budget, assets, risk tolerance, family situations or activities which may affect the type of insurance that may be right for you. In addition, state insurance laws and insurance underwriting rules may affect available coverage and its costs. Guarantees are based on the claims paying ability of the issuing company. If you need more information or would like personal advice you should consult an insurance professional. You may also visit your states insurance department for more information.
Both loans and withdrawals from a permanent life insurance policy may be subject to penalties and fees and, along with any accrued loan interest, will reduce the policies account value and death benefit. Withdrawals are taxed only to the extent that they exceed the policy owner’s cost basis in the policy and usually loans are free from current Federal taxation. A policy loan could result in tax consequences if the policy lapses or is surrendered while a loan is outstanding.
This is a hypothetical example and is not representative of any specific product. Your results may vary.