How Much Life Insurance Do I Need?
Life insurance is a contract between you and an insurance company to protect your family in case of your death, by providing funds to pay outstanding bills, taxes and income loss. The premium you pay to keep a contract active is based on the type and amount of life insurance you buy and your chance of death while the policy is in effect.
An individual’s need for life insurance changes over their lifetime. At any age, you should consider your personal circumstances and the standard of living you wish to maintain for your dependents. In most cases, you need life insurance if someone depends on you for support like in the following situations:
• Funeral Costs- money for funeral and burial expenses
• Debt - bills, credit card debt, and student loans
• Mortgage Protection - pay off a mortgage or monthly rent payments
• Income Replacement - provide an additional income source so surviving family members can maintain the same standard of living.
• Education - ensure that your dependents’ education is covered
• Taxes - estate and inheritance taxes can be pre-funded
A person typically purchases a life insurance policy with the intent to replace income in the event of their death. Professionals recommend that you buy 5-10 times your current annual income. This does not include current assets or special needs your family may have.
To determine how much life insurance you need, you should identify the financial impact of a premature death as a specific dollar cost. You can calculate your needs with our life insurance calculator.
If you are married, you should consider the financial impact of the death of either spouse. Plus, you should think about how long each need will last and whether it will increase or decrease over time. Once you calculate the financial impact of a premature death, you can compare that amount to the resources you currently have available. If there is a difference, you can decide which needs to address first and begin to explore alternative ways to fund any shortfall. Focus first and spend your premium dollars on those needs with the greatest financial impact and the most immediate time frames.
There are many kinds of life insurance, but they generally fall into two categories: term insurance and permanent insurance.
Term insurance offers protection for a certain time period. It pays a benefit only if you die during the term. Some term insurance policies can be renewed when you reach the end of the term, which can be from one to thirty years. The premium rate increases at each renewal date.
Advantages
- Initial premiums are usually lower than those for permanent insurance, allowing you to buy more coverage at a younger age when the need is often greatest
- Term insurance works well for covering temporary needs like car loans or mortgages
- Proceeds are not taxable to your beneficiaries
Disadvantages
- Premiums increase as you get older
- Coverage may terminate at the end of the term
- The policy usually does not offer cash value
There are a few main reasons for buying term life insurance depending on the length of time that most fits your needs.
5 Year – The more specific your need for insurance is, the shorter the term period should be. For example, if you have a child going to college for four years and no need for the insurance after, a 5-year term may be right for you.
10 Year – A 10-year term period works, for example, if you are a business owner with a key employee that you want to cover with life insurance but don’t expect the employee to stay in the same position.
15 Year- Many families choose 15-year term policies to replace one or both of the parents' income(s) in the event of death. This is especially useful in households where the children will be self-supporting before the 15-year term has expired, or your home has a 15-year mortgage.
20 Year- A 20-year term is a very common choice for people seeking longer-term coverage because of the cost-effective nature of the premiums. The total premium on a 20-year policy generally costs less than purchasing a 10-year policy and keeping the same for an additional ten years. If you have young children at home, a 20-year term policy could be the right choice for seeing them through their college years.
30 Year- This is a good choice for people with a 30-year term mortgage. The life insurance policy can cover the entire period to alleviate the burden of mortgage payments in the event of your death.
What Do I Do When My Term Period Ends?The insurance company will contact you to tell you that the policy is about to expire and provide you with three options.
Keep your existing policy - You can still pay on the existing policy after it expires. It will automatically continue as an extension of your existing policy. If your health is bad, you will not need to provide medical evidence of your insurability. However, with this option, the policy likely becomes annually renewable so the premiums will increase every year.
Get a new policy - Depending on your age and health, you can apply for a new policy with either your existing company or a new company. The new policy replaces the former policy but be careful when doing this because new underwriting requirements must be met. Be sure to keep your old policy in force until you know the outcome of your new application. If your health has deteriorated you might face higher premiums or even be refused coverage.
Convert to a permanent policy - You can convert your policy to a Permanent Life Insurance policy and lock in your premiums at a higher level for the rest of your life.
Permanent insurance provides lifelong protection. As long as you pay the premiums, the death benefit will be paid. These policies are designed and priced for you to keep over a longer period of time.
Permanent policies include: whole, universal, and variable life. Unlike term insurance policies, most permanent policies have a cash value to provide you with the following options:
- You can cancel all or part of the policy and receive the cash value as a lump sum. If you surrender the policy early on, there may be little or no cash value.
- If you stop paying the premiums, you can use the cash value to continue your current insurance protection for a specified amount of time or to provide a lesser amount of coverage over your lifetime.
- You can borrow from the insurance company, using the cash value as collateral. Unlike loans from most financial institutions, the loan is not dependent on credit checks or other restrictions. You must repay any loan with interest or your beneficiaries will get a reduced death benefit.
With all types of permanent policies, the cash value is different from the policy’s face amount. The face amount is the money that will be paid at death or policy maturity. Cash value is the amount available if you surrender a policy before its maturity or your death.
There are three main types of permanent insurance:
- Whole life is the most common type. Premiums generally remain constant over the life of the policy and must be paid periodically in the amount indicated in the policy.
- Universal life allows you, after the initial payment, to pay premiums at any time, in varying amounts, subject to certain minimums and maximums. You can increase or decrease the death benefit more easily than under a traditional whole life policy.
- Variable life provides death benefits and cash values that vary according to the performance of a portfolio of investments. You can allocate premiums among a variety of investments including stocks, bonds or guaranteed interest accounts.
Advantages
- Protection is guaranteed for life as long as premiums are paid
- Premium costs can be fixed or variable to meet personal financial needs
- You can accumulate cash value, tax deferred
- The policy accumulates cash value that can be borrowed against to pay premiums
- Cash value can be partially or totally surrendered for cash or converted into an annuity
Disadvantages- Minimum premium levels can make it difficult to buy enough protection
- Permanent insurance may be more expensive than term insurance if it is not kept over a long time period