Here’s the next in a series of monthly posts focusing on meeting small, manageable financial objectives in order to create a path to overall financial success. You can find July’s post here.
How do you know if you need more life insurance? Should you have any at all? What kind? What should you look for?
It’s likely that you have people, other than yourself, who are depending on either your income or on the services you provide (stay-at-home spouses and parents, that means you!), then you should have a policy in place to replace that income or that work if you die. There will probably also be end-of-life costs like medical and funeral expenses, and you want to make sure the money is there for those too.
At its most basic, life insurance pays a stated benefit to your named beneficiaries if you die. Very broadly, life insurance is split into two types: term and permanent.
Term insurance offers just the death benefit: you purchase a policy - let’s say it’s a 20-year, $1 million policy - and pay the premiums. If you die during the 20 years, your named beneficiaries get $1 million. If you don’t die, the term ends and no one gets anything (you haven’t died though, so that’s pretty good). It’s simple and inexpensive. And if you stop paying your premiums during the term, the policy lapses and you no longer have coverage. Many policies are renewable, meaning that once the term ends, you can renew for an additional term.
Permanent life insurance offers the death benefit of a term policy, but without a predefined term: as long as premiums are paid, coverage continues. In addition, it builds up a cash value over time that can be withdrawn, borrowed against, or used to pay premiums later. This sounds nice, but in practice the additional savings feature is pretty expensive, and in my view the extra money you would pay for a permanent policy over a term policy is better directed toward a savings or investment strategy with a stated goal and characteristics you control (and with a return you get to keep) - I like to keep functions separate, so insurance should be insurance and investments should be investments. Permanent insurance has its place, but generally speaking, until you have a pretty complicated estate situation, term is just fine.
But how much do you need? There are several factors that affect the calculation:
- How much annual income needs to be replaced, and for how long? OR
- How much will it cost to hire someone to provide the services you do, and for how long - this means childcare, meal preparation, house upkeep and maintenance and other tasks? Think seriously about how life would be impacted
- If there is a stay-at-home spouse, would they be able to return to work if needed? Would they require skills training or education?
- Do you want to provide college funding? If so, how much and when will the children start college?
- Do you have a mortgage you would want to pay off so that your family can remain in the home?
- What other debts are outstanding?
- How much do you have in savings now, both in qualified retirement accounts and taxable accounts?
- Do you anticipate needing to provide for elderly parents?
- How much insurance do you have now? It’s likely you have some coverage through your employer, probably equal to one year’s salary. Some employers allow you to purchase more (supplemental) coverage, and even spousal coverage, and this can be a good deal price-wise. But remember that this coverage is not portable - if you leave your job, you can’t take the policy with you, so make sure the new job has similar options.
Everyone’s situation is different, and a good financial planner will help you navigate the particulars. But there are some needs analysis calculators available online that will at least get you in the ballpark. Remember too that you don’t necessarily need the same amount of insurance for the entire term: you likely will need the most while your children are very young and labor-and-cost intensive. Term layering is the strategy of “stacking” policies of different terms, to give you the most coverage when you need it, and less as those needs cease - the kids are out of the house, the mortgage is nearly paid off, etc. It often costs less than one large policy covering the entire term.
A nice feature of life insurance is that the process to claim the benefit is pretty simple: the beneficiary simply calls the insurer to file a claim, provides a death certificate, and the benefit is paid. It’s tax-free to the beneficiary and occurs separately from the will or other estate issues, so there’s generally no delay and can be done very soon after death - helpful in covering those final expenses.
Very very important though: make sure those beneficiaries are correct. In fact, that’s really this month’s objective, along with understanding your life insurance needs: take a look at your beneficiaries (life insurance policies, 401ks, IRAs) as well as how your bank accounts are titled, and make sure they say what you want them to say. These instruments are considered “will substitutes”: that means your will doesn’t dictate what happens to them when you die, the beneficiary form or bank account title does. And if an ex-spouse or parent is named the beneficiary instead of your current spouse, well, that’s who will get the money. So make that the one thing you do right now: look up the beneficiaries and update as needed!