Do you need life insurance? How much life insurance do you need? What type is appropriate? You should review your life insurance needs each time you have a major life event like getting married, having a child or buying a home.
Here is what you need to know to properly plan for your life insurance needs—to buy enough and to get the most for your money.
Do You Need Life Insurance?
The purpose of life insurance is to provide a source of income, in case of your death, for your children, dependents, or other beneficiaries. Whether should buy life insurance depends on whether anyone is depending on your income. If you have a spouse, child, parent, or some other individual who depends on your income, you probably should consider life insurance.
Situations to Determine if Life Insurance is Right for You
FAMILIES OR SINGLE PARENTS WITH YOUNG CHILDREN OR OTHER DEPENDENTS
The younger your children, the more insurance you need. If both spouses earn income, then both spouses should be insured, with insurance amounts proportionate to salary amounts. If the family cannot afford to insure both wage earners, the primary wage earner should be insured first, and the secondary wage earner should be insured later on. A less expensive term policy might be used to fill an insurance gap. If one spouse does not work outside the home, insurance should be purchased to cover the absence of the services being provided by that spouse (child care, housekeeping, and bookkeeping). However, if funds are limited, insurance on the non-wage earner should be secondary to insurance on the life of the wage earner.
ADULTS WITH NO CHILDREN OR OTHER DEPENDENTS
If your spouse could live comfortably without your income, then you will need less insurance than the people in the first situation. However, you will still need some life insurance. At a minimum, you will want to provide for burial expenses, for paying off whatever debts you have incurred, and for providing an orderly transition for the surviving spouse. If your spouse would undergo financial hardship without your income, or if you do not have adequate savings, you may need to purchase more insurance. The amount will depend on your salary level and that of your spouse, on the amount of savings you have, and on the amount of debt you both have.
SINGLE ADULTS WITH NO DEPENDENTS
You will need only enough insurance to cover burial expenses and debts, unless you want to use insurance for estate planning purposes.
Children generally need only enough life insurance to pay burial expenses and medical debts. In some cases, a life insurance policy might be used as a long-term savings vehicle.
There is less of a need for life insurance after retirement, unless it is to be used for other estate planning purposes. You may need to provide an income for the second spouse to die if your retirement assets are not large enough. Further, you will need some insurance to pay burial expenses, final medical costs, and debts.
So You’ve Decided Life Insurance Is Right For You!
After deciding on the amount of coverage you need, you can decide on the type of insurance product to best fill those needs. Although the array of insurance products may seem confusing, there are really just two types of insurance:
- Term: whereby you pay for coverage for a specified amount of time, and if you die during that time the insurer pays your survivors the death benefit specified
- Cash Value: whole life or universal life—which, in addition to paying a death benefit, also provides you with some other redeemable value.
For individuals age 40 or less, a term policy will almost always be less costly than a whole life policy. Although term policies do not build cash values, many are convertible to whole life policies without a physical exam. Thus, a term convertible policy may be a good option for someone who is under 40. There are four primary types of term life insurance:
- Renewable: With the typical renewable term policy—the most common type—the policy renews automatically every year. You do not need to take a physical or verify the fact that you are employed. The premium goes up at the beginning of each new term to reflect the fact that you are older. Most renewable term policies can be renewable until you reach age 70 or so.
- Re-entry: With this type of policy, you must undergo a physical exam after a certain period, or pay an extra premium.
- Level. With level term policies, the premium is guaranteed to stay the same over a certain period. This period may be shorter than the term of the policy.
- Decreasing: With a decreasing term policy—a good option for insuring mortgage payments—the face amount of the policy decreases over time while the premium payments remain the same.
CASH VALUE INSURANCE
There are four types of cash value life insurance: whole life, universal life, variable universal life and variable whole life. The first two types are the most common and have a guaranteed cash surrender value; in the last two types, the cash surrender value is not guaranteed.
This is the traditional life insurance policy. It provides a death benefit, has a cash value build-up, and sometimes pays dividends. You do not need to renew a whole life policy. As long as you pay your premiums, you will have coverage, usually until your death. The premium for a whole life policy remains the same for the amount of time you own the policy. Part of each premium goes into the cash value of your policy. Your cash value, which is actually an investment, is guaranteed to grow at a fixed rate. You do not have to pay current income taxes on the growth in the cash value—it is tax-deferred and you can borrow against it or make partial withdrawals.
Universal life, also known as “flexible premium adjustable life,” is similar to whole life, but offers more flexibility in terms of payment of premiums and cash value growth. With a universal life policy, your monthly premium amount is first credited to your cash value. The company then deducts the cost of your death benefit and the expenses of the policy. These costs are about equal to what it would cost to buy term coverage. As with whole life, your cash value grows at a fixed minimum rate of interest. The growth of the cash value is tax-deferred, and you can borrow against it or make partial withdrawals.
VARIABLE UNIVERSAL LIFE
Variable universal life allows you to choose the investment for your cash value. You have a potentially greater cash value growth, but you also have added risk, depending on the type of investment you choose.
VARIABLE WHOLE LIFE
With variable whole life, the death benefit and cash value will depend on the performance of an investment fund that you choose. Again, you have potentially greater reward, with its accompanying risks.
Shopping For Life Insurance
In order to be able to shop for the best premiums, it’s a good idea to know how premiums are calculated by insurers. Bear in mind that premiums vary among insurance companies, and it is a good idea to ask several insurers for their rates. Insurance companies place individuals into four risk groups: preferred, standard, substandard, or uninsurable. The premiums charged will be commensurate with the category you are placed in. The good news is once an insurance company approves you for coverage, you cannot be dropped unless you stop paying your premium.
Here Are Some Questions to Ask About Policies Before You Buy:
- How do cash values accumulate? An early, rapid build-up is generally preferable.
- How has the policy’s cash value performed in the past? You can get this information from a publication called Best Review, Life and Health. Determine how the policy performed in comparison with the company’s projection and with other insurers.
- Are any special features merely bells and whistles, or do they add value for you?
- What is the company’s rating with Best, Standard & Poor’s, and Moody’s? You can find these publications in public libraries. The rankings should be in the top three to ensure that a company has financial stability.
Got a question about life Insurance? Ask the iGrad community and we’ll see if we can’t get you an answer.