Exploring Life Insurance - Does It Make Sense For You?
Part of financial planning deals with legacy, and making sure you can still provide financial support for your loved ones when you're gone.
One way people approach this objective is purchasing life insurance.
When you have people depending on you, that’s when insurance can come into play. Should your number be called too early, and you were the main provider for your family, life insurance can help cover the everyday living expenses, bills (mortgage payments), college tuition, or help replace the income that is no longer coming in.
Let’s explore the most common types of life insurance:
Term life insurance
When you hear ‘Term Life’, think temporary coverage.
Term Life is the most straightforward type of insurance and usually the cheapest option.
Coverage typically lasts for 10, 20, or 30 years and the premiums remain level throughout the term. After the term, these premiums skyrocket.
Should you pass away during the term, your beneficiaries will receive the death benefit tax free.
Certain term life policies can be converted to long-term policies at a future point. This is a useful benefit if your life changes and you need additional protection.
Permanent Life Insurance:
There are two main types of permanent life insurance: whole life & universal life.
These types of policies are more expensive than term life, as you are covered for as long as you live.
Universal life insurance provides more flexibility. You can change the premiums and the death benefit should you need to.
These types of policies generate a ‘cash value’ inside the policy. This ‘savings account’ inside the policy grows at a small percentage rate each year.
Things to keep in mind with the ‘cash value’:
You are not earning a great rate of return on this ‘savings account’.
The cash value will be minimal in the beginning years of the policy. You’ll typically need to pay premiums for several years before there’s enough cash value to be useful.
You can tap into this cash value should you need funds a few different ways:
Cancel the policy and receive the cash value. You could be subject to surrender fees and may not receive the entire cash value you see on your statement.
Make a withdrawal without canceling the policy. You shouldn’t owe taxes if you withdraw less than the amount of premiums paid to date. This will decrease the death benefit that the beneficiaries inherit.
Borrow from the policy via a loan. You will have to pay interest on the amount you withdraw. Isn’t it funny that you pay interest on the ‘savings account’ that you paid into?? Also, if you die before paying it back, the amount you owe is deducted from the death benefit.
These are the basics with life insurance. There are many different flavors and strategies to leverage insurance to help give you piece of mind.
How much coverage should you get?
This will vary but a rule of thumb is multiply your salary by 10 ($100,000 salary x 10 = $1,000,000 death benefit).
Assess how much debt you have and what assets you currently have saved. Let’s say you have a $300,000 mortgage. If your death benefit will pay this off and then some, that helps your family’s cash flow and eliminates a major burden for them.
If you are young, and not many people depend on you currently, then I probably wouldn’t recommend purchasing life insurance.
The case can always be made why insurance makes sense. Just remember - whoever is selling you the policy is making some sort of commission.
Consider the opportunity cost of paying the premiums for your policy vs. investing/saving that money elsewhere.
Another easy way to make sure your loved ones are taken care of is to name beneficiaries on your accounts (IRAs, 401ks, investment accounts, etc.)
This helps avoid the ugly world of probate and they will certainly appreciate that.
Should you have more detailed questions about life insurance, and want to know if it makes sense for you, please reach out!
Disclosure: This material is for general information only and is not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.
All investing includes risks, including fluctuating prices and loss of principal.