KJ: Now that we’ve covered an introduction to life insurance, we wanted to focus on some of the common uses for life insurance coverage.
Common uses for life insurance
Life insurance in my mind has four different purposes:
(1) income replacement for a period of time (for a few years or can be indefinite particularly for a non-working or lower income spouse) for any surviving dependents (underage children, family members requiring support, spouse, etc.),
(2) to fulfill current or future debts and obligations (children’s education, payoff of a mortgage or other loan to help reduce the surviving heir’s living expenses),
(3) help with taxes or liquidity for an estate, and
(4) payment of final burial expenses.
Topic (3) is beyond the scope of this post and typically only applies to individuals that have large, and very illiquid assets in their estate that may take some time to sell – family business, lots of real estate or oil & gas interests, etc. Uncle Sam doesn’t much care about what types of assets are in your estate, and if you owe estate taxes, you may need some form of permanent life insurance coverage to address this tax need particularly if you can’t (or don’t want to) sell the assets within a quick period of time. Fortunately for most of us out there, we don’t have estates with around $10,500,000 ($5,250,000 can pass tax-free in 2013 per person, so double for spouses), so final taxes and the concept of “liquidity” may not be an issue. Do note that some states have an inheritance tax, so be mindful of this component if you live in one of those states.
How much coverage do I need?
When putting pen to paper for how much insurance you need, start with a list of the needs for items (1) – (4) above. Are you wanting income replacement for two years for $40,000, payoff your mortgage and other loans totaling $150,000, and paying for estate expenses of $20,000? If so, then you would need at least $250,000 in coverage. This final result may give you an indication of how much total coverage you need, and the next step is considering which of the above can be satisfied by term insurance and what should be best suited for some form of permanent coverage.
Identifying which one is right for you and your family
In the case of a goal that terminates after a predetermined period of time – as is the case of funding your children’s higher education (whether you should or should not be responsible for paying all or part of the education costs is a topic for another discussion) – a term policy could meet all your needs. In this case, you know your children aren’t going to be in school into their thirties (well, at least let’s hope not on your wallet!), so you have a good idea of the time you’ll need insurance in force in case you die prematurely and aren’t able to fund their education. On the other hand, if your goals are a bit more nebulous in terms of timing, then maybe a form of permanent policy is up your alley.
Since you typically have to go through a rigorous application for life insurance, it is possible (and not all that infrequent) that you may be denied coverage now or some time in the future, and even if you have current coverage in force doesn’t mean you will be able to qualify for the same rates (or at all) in the future to increase your coverage, so one consideration in the decision of ‘term’ versus ‘permanent’ coverage is whether there’s a chance you may need to extend the coverage at a later date.
Also, provided you continue to save, build up your emergency fund, build your retirement funds, and save for your other goals, then your insurance needs may actually decrease over time – i.e. if you save over time, maybe you can build up savings to cover that income replacement, so you may no longer have a need for that coverage amount in your life insurance. Particularly as you age, you may have fewer remaining years of income replacement needed for a surviving heir, plus, your children may (hopefully!) be out of the nest and on their own without needing cash from the parentals.
In your evaluation of “how much is enough,” keep in mind that most insurance representatives get paid more based on the size of the insurance policy issued, so it is important to find a reputable advisor that is aligned with your interests to make sure the coverage is both adequate in amount and reasonable in terms of costs that factor the stability of the life insurance company, expenses within the policy, etc.
What do I do next?
It’s definitely not an easy maze to navigate, so instead of searching for coverage amounts and navigating the maze yourself, consider consulting a licensed professional that can best make a recommendation in light of your other goals and objectives. The Financial Planning Association has a great search system that can help connect you up with an advisor in the area depending on the services you are looking for, and if you are just getting started or don’t meet the requirements of some of the firms, there is a great Pro Bono arm of their organization to help those in the community for free.
- Do you carry life insurance?
What types of coverage do you have?
Tells how you made the decision and navigated the complex products available.
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