Why do we need to think about it?
No one really wants to think about life insurance. Personally, considering my mortality is downright unpleasant. But if you are like me and have people who depend on you financially, it is not something you can avoid. Not having insurance can leave people you care about exposed to potential financial hardship. Having the appropriate amount of life insurance protects your loved ones in the event of a worst-case scenario.
Common uses for life insurance proceeds are:
- Pay for funeral costs of the deceased.
- Payoff household debt such as mortgage or credit cards
- Finance future needs you would have paid, like your child’s education.
- Help pay bills and meet the ongoing living expenses of your loved ones.
How do I know how much I need?
The amount of life insurance you need changes as your financial situation evolves. For younger people, 20s – 40s, there are two main components to consider. First, how much will be required at death to meet financial obligations. This number should take into account final expenses, which include uncovered medical bills, funeral, and estate-settling costs. It should also cover outstanding debts such as mortgage balance, student loans, and credit card debt. Lastly, it should consider major obligations you would have provided had the awful turn of events not happened; the most common item that falls into this category is the education of a child.
The second significant factor when determining how much insurance you need is, the future income needs to sustain the household quality of life. Most US households depend on two incomes to maintain their lifestyle. Could the family continue their standard of living on one income?
If you are the primary income source for the family, this number will be higher. But even if you are a homemaker, you are making financial contributions such as childcare, transportation, and many other essential household activities. The replacement cost of which is often severely underestimated.
Here is a link to one of our favorite online insurance needs calculators. Check it out and see what you come up with for your situation.
So now I know kind of how much I need, what kind should I buy?
The reason I wanted to break out specific costs and show you how those play into the final amount of insurance was to help answer this question. As you can see from the numbers above, a big chunk of the things you are insuring will be decreasing annually. Mortgages decrease over time; if you have kids, hopefully, you are saving into a 529, reducing that potential cost, and as you accumulate more assets, those assets will protect your family, and the need for insurance diminishes.
So, the longer you live, the more you save, the less insurance you need. For that reason, at PSWA, we generally advise younger clients to consider term insurance to manage these life events. For younger people who live a relatively healthy lifestyle, term insurance is very affordable. The factors that increase the cost are age, general health, and tobacco use. Term insurance provides fixed premiums for a set term; 20 or 30-year terms are the most common and typically line up with life events. Term insurance is non-binding for the insured, meaning if your financial situation changes and you no longer need the same level of coverage, you can just stop paying for it without any penalty. As long as insurance premiums get paid on time, the insurance company must honor the contract.
For some people, the idea of paying years’ worth of premiums and have nothing to show for it seems like a bad deal. If you are one of those individuals, you may want to consider a convertible policy rider; this feature allows the policyholder to convert the term policy into a permanent policy such as whole life or universal life insurance.
Why not get permanent insurance to begin with?
Typically, whole life and universal life insurance have much higher premiums $20,000 compared to $1,000 per $1 Million of coverage. Additionally, while they do accumulate cash value with each premium payment, fees and costs eat away at the earlier premiums reducing the cash growth initially. The longer you hold the policy, the more those fees are spread out over premiums paid. This type of policy will also have surrender fees meaning you pay fees to get your cash back if you need it early in the life of the insurance contract. For those reasons, we typically stick with the term for the protection and recommend additional savings be invested in 401ks, 529s, and other vehicles to help the family build their net worth during this phase of the financial journey.
If you have questions about your own insurance needs or are looking for guidance on balancing insurance and other savings priorities, give us a call!