What’s in Life Insurance?

Nobody likes to think about their own mortality. It’s the fear of the unknown that makes us most uncomfortable about broaching the topic, whether we’re nervous about what kind of afterlife awaits us or what would happen to those around us after we’re gone. But, as a pragmatist and an adult, it’s essential that you consider all possible outcomes – good or bad – and their consequences. A sturdy life insurance policy offers your loved ones financial security when you can no longer provide it.

If you’re considering buying a life insurance policy, you’re primary question may be whether or not the short-term costs justify the potential long-term benefits. Can you afford the monthly payments for a policy that would cover your family? A report recently released by LIFE Foundation and LIMRA found that a lack of information may be causing many to bypass getting a policy, finding consumers estimate that life insurance costs almost three times its actual price. Eighty-three percent of consumers surveyed said they haven’t purchased a policy because they think it would be “too expensive.”

After conducting the proper research, you’ll find that covering monthly payments for life insurance is hardly burdensome. Smart Money provides a rough example in which a person buying a $250,000 policy would pay $260 per year, which breaks down to about $22 per month. Keep in mind that costs vary depending on your age at the start of the policy, the length of the policy, your health, and where you land on a mortality table used to determine the probability of you dying before your next birthday.

Who Needs Life Insurance?

You can afford life insurance, but is it a necessity? The answer to that question depends on the person. Ultimately, only you can determine if you need it based on factors such as your family situation, combined family income, and savings.

  • Working married couples with children: With two sources of income, you and your spouse have carved out a comfortable existence for your family. You’ve made significant progress in paying off your debt, including your mortgage, and are saving for your children’s college education. These are long-term goals that would be disrupted with the death of you or your spouse. A married person should have a sizeable life insurance policy not only to cover their financial goals, but to ensure their family maintains the same lifestyle until their children are prepared to make their own way.
  • Married couples with a stay-at-home parent: All of the above applies to married couples who rely on one income, with the consideration that if the stay-at-home parent were to die, the income earner would have to cover the cost of care for their children.
  • Single parents: If you’re the primary guardian of your children, then it’s absolutely essential that you have a comprehensive life insurance policy to cover their cost of living, college education, and your own debts in the unfortunate event you were to pass away. A trusted guardian would ensure the money is used properly so that your kids grow up in a healthy environment.
  • Retired individuals with or without an estate: It’s not typical for retirees to purchase life insurance because, ideally, they have a comfortable amount of savings, which should cover them for the rest of their lives. However, a policy would enable their spouse to pay for funeral expenses and estate taxes when they pass away.
  • Small business owners: Operating a business on your own entails lots of responsibility. Your absence for an extended period of time, let alone permanently, can hurt the business irreparably. A sizeable life insurance policy would replace the missing income and allow your family to ensure the business doesn’t miss a beat and ultimately falls into the right hands. The presence of a buy-sell agreement would give the remaining business owners the opportunity to purchase the company at a previously agreed upon price.
  • Single individuals: If you’re single, then you’re not generally advised to purchase life insurance because you don’t have financial dependents. However, you may be in a situation where a death benefit is warranted. For example, if you have siblings or aging parents who could use financial assistance in your absence, then you could list them as beneficiaries. If you plan to get married and have kids, you can select a policy now, when you’re young and healthy, to get the lowest rates.

Term Life Insurance vs. Whole Life Insurance

Your life situation will also determine which type of insurance you should buy – term or whole life. There are two characteristics that distinguish the two. Whole life lasts for the remainder of your life unless you cancel the policy and it includes an investment component consisting of stocks and bonds that builds cash value against which you can borrow. Term life lasts for a set term you determine when taking out your policy, and you only receive a death benefit. That is to say, it’s life insurance in its simplest form without any additional components.

Individuals who aren’t just scraping by financially and wish to invest in another vehicle for retirement typically consider purchasing a whole life policy. After a certain amount of cash value has been accumulated, policy holders can cash it in and invest the money how they see fit. Premiums are fixed, and beneficiaries receive a non-taxable lump sum once you die.

Many financial advisers recommend consumers choose a term life policy over whole life because it’s a better value. Premiums are less expensive, especially for those under the age of 50, as the premiums cover only a fixed term to which you and the insurance company agree. There are no accompanying fees and commissions due to an investment component, an aspect of whole life that isn’t necessary for those who already have a retirement plan in place.

Term life policies allow you to cover yourself for only the period of time you think you should be covered. For example, if you plan to retire in a financially stable situation at the age of 55, then you won’t need life insurance past that age. By allowing it to expire in a short period of time, you will ensure your premium remains low. Similarly, if you merely want life insurance to cover the period of time you’ll be paying your mortgage so that your family could pay it off in the event of your death, then you can take out a policy that corresponds with your mortgage length.

Calculating How Much Coverage You Need

There’s no standard formula to use to determine how much coverage you need specifically. It’s not that easy. The industry rule of thumb is that you should purchase eight to 10 times your yearly income, and that can serve as a good starting point, but it’s too simplistic because your total could be more or less depending on a variety of factors affecting your life. If you’re part of a newly married couple with no kids, you shouldn’t be held to the same standard as a financially secure couple nearing retirement with two kids in college. Determine how much you need by asking yourself the following questions:

  • How much does it cost to die? As morbid as it sounds, it’s a question you must answer. The Federal Trade Commission estimates that the traditional funeral with casket and vault costs about $6,000, excluding flowers, obituary notices, and acknowledgement cards – such additional expenses can push the cost into five figures. Every married couple should have a plan in place according to their final wishes.
  • How much debt will you need to cover? The average American is carrying $78,030 in debt, according to Experian. Members of Generation X, the group of people most likely to have a family with dependent children, carry the most average debt – $111,121. To ensure the burden of this debt isn’t passed to your spouse if you die, you should determine a safe amount to have so that it can be paid off. That should include everything you owe on your mortgage, students loans, car loans, and any other private loans you have taken out and not paid off.
  • How much income would need to be replaced?With debt and funeral expenses covered, figure out how much income you would need to replace to maintain your current lifestyle (assuming it isn’t excessive). Take into account the number of years you would be working and the anticipated annual percent increase along with inflation. What additional costs may the family incur in your absence? If you have a child with special needs, you may need to set aside enough money to ensure they’re taken care of for the duration of their life. The same can be said for a family member with a difficult medical history.
  • How much will it cost to send my children to college? For most middle class families, it’s a given their kids will attend college. The total cost of college will vary depending on how many kids you have and when they go to college. If one or more of your children plan to attend a private college, then it will be even more expensive. And remember, the average cost of college is continuously rising, so it will be much more expensive to attend college 10 years from now.

Your current financial reality, for better or for worse, will dictate how much coverage you need. Either way, it’s best to purchase a policy with a death benefit that’s a little more than you estimate you’ll need. Better safe than sorry.

Terms You Should Know

As you begin to research life insurance policies, you may encounter a few terms with which you’re unfamiliar. It’s understandable given that you may not have known anything about life insurance beforehand – it’s not exactly a topic that inspires strong curiosity. Here’s a brief list you can reference:

  • Beneficiary: This is the person who receives the death benefit when the insured dies. In many cases, this is the spouse or children.
  • Cash Value: The amount your whole life policy is worth if you cancel it while you’re still alive. When you’re making payments, some of the money goes into a cash value account that grows with time, free of taxes, which is another reason why whole life policies are more expensive than term life policies.
  • Decreasing Term: A type of policy with a death benefit that decreases during the life of the contract until it reaches zero.
  • Expiry: When the life insurance policy reaches the end of its period of coverage.
  • Fixed Benefit: A benefit with a concrete dollar amount during the life of the policy.
  • Level Term: A type of policy with a face value that remains the same from beginning until the end. The premium remains level for a set amount of years as well.
  • Life Expectancy: The number of years you’re expected to live from the time you get the policy, based on age, as determined by the mortality table.
  • Preferred Risk: If you’re deemed a preferred risk by an insurance company, then you pose a less-than-standard risk to the insurance company. This is determined by gauging your standing in areas of health and lifestyle.
  • Provisions: Explanations regarding conditions and benefits in the policy.
  • Rider: A supplemental agreement attached to a policy to expand or restrict coverage. A child rider, for example, specifies a death benefit for a child up until a certain age.
  • Standard Risk: If you’re deemed a standard risk by an insurance company, then you pose no more risk than the average individual. As with preferred risk, this is determined by gauging your standing in areas of health and lifestyle.