I continue to be surprised how few people have life insurance. Perhaps it’s our unwillingness to think about the possibility of an untimely death. Some people think they just don’t need life insurance, or it could be they just don’t know how much life insurance they need. Well, whatever your reason for not having life insurance, I hope the answers to the questions below will help you make an informed decision.
Do I need life insurance?
Life insurance is not for everyone. If you’re single, not responsible for anyone else, and have enough saved up to take care of any outstanding debts or funeral expenses, you don’t need life insurance. However, if you have people that depend on you and your death would leave them in a difficult financial situation, then life insurance is strongly recommended.
Life insurance is NOT necessary for those who have diligently saved and have enough assets to provide for their loved ones. As a general rule, if you’re managing money well, you should need less and less life insurance coverage as you get older.
What type of life insurance do I need?
There are two major types of life insurance available. Term life insurance is for a specific period of time at a specific rate, which is fixed. Once the term has completed the policy and the benefit ends. It’s pure death benefit, with a primary use to provide coverage for financial responsibilities of the insured or his or her beneficiaries.
The other type is whole life insurance and it’s permanent. As long as the premium is paid it doesn’t expire. The rates are also fixed, although they are significantly more expensive because they have an investment component included, which grows at a guaranteed rate of return.
The best and most affordable life insurance is term life insurance. It's designed to provide a death benefit, which is what life insurance is supposed to do. The problem with whole life is that the fees for the investments are high and rates of return are low. For this reason, I personally recommend never mixing life insurance with investing. You can do much better by investing in a low-fee index fund than you can through a whole life insurance plan.
How much life insurance do I need?
To determine how much life insurance you’ll need, three questions need to be answered. 1) How much will your loved ones need? 2) For how long will they need it? 3) How much do you have right now?
Start by calculating your family’s immediate needs after you die. In the short term, they’ll need money to provide for your funeral costs and a way to continue paying for your family’s monthly living expenses. Yet another strong reason to have an emergency fund of 3 to 6 months of income saved. A death benefit claim can take anywhere from 10 to 60 days to pay out.
At a minimum, you should provide enough benefit to replace your income. There’s a general rule that life insurance should provide your loved ones enough for them to live a similar lifestyle for the next 10 years. So, if you make $50,000 a year then a $500,000 policy is recommended. However, that’s a guess, and you may need more or less depending on your unique financial situation.
A better way to calculate how much life insurance you’ll need is to look at what you’re income and expenses are right now. How much does it cost your family to live for one year? Once you have the yearly cost of living you can multiply that by 10 or the number of years you want to provide for them to determine the amount of life insurance you’ll need. But that’s not all...
A few other things to consider:
1. Current debt
If there’s debt such as car payments, mortgages, and credit cards, add your balances and include the total in your final number. You’ll want your family to pay off these balances instead of just keeping up with the monthly payments.
2. Current savings
Add up your regular savings accounts, retirement accounts, stocks or bonds you own, real estate, or any other assets you own that would be sold after your death. You may like your muscle car or boat but they may not be assets your wife will want to keep. Once you’ve added the value of all these accounts and assets subtract the balance from the total life insurance amount.
3. Future fixed expenses
Don’t forget to include college tuition if that’s something you and your spouse agreed to fund and any retirement shortfall for the surviving spouse.
It’s important that you have a proper view of life insurance. Life insurance is not a way to make your family rich when you die, nor is it an investment. Life insurance is just like any other insurance. It’s a way to “ensure” your family is prepared in case the unexpected happens.
Life insurance can be an incredible blessing to your family should something unexpected happen to you or your spouse. As inexpensive as term life insurance is for most people, it’s foolish not to have it. There are areas of spending you should always look to eliminate or reduce, this should not be one of them.