Before you decide to buy life insurance, take the time to make sure you need life insurance. If you do need insurance, you have to make several choices.
1) Term or Permanent coverage
Life insurance is generally split into two categories, term and permanent. Whole life and universal life are called permanent policies because they build cash value as you pay your premiums. If you stop paying your premiums, the insurance company will start to use the cash value until no money is left in the account. You can also borrow against the cash value of a permanent policy. Permanent policies act as a savings vehicle combined with actual insurance. Term insurance is more of a pure insurance product. It protects the beneficiaries against a catastrophic, common risk to their financial interests.
Term insurance is typically much cheaper than permanent insurance. I only recommend permanent insurance for people who need the tax benefits. Some people also use permanent policies as a convenient way to save money. Generally, buying a term policy for your insurance need and using the rest for mutual funds or other investments will yield a better return.
If you are buying permanent insurance, try to get universal life as opposed to whole life. Plenty of people attempt to justify whole life as being more secure. It is an older and simpler product. Universal life is a newer, more flexible financial product with a more transparent investment structure. Your policy will be affected by the performance of the insurance company you choose. Of course, price and availability will affect your choice.
2) Amount of coverage
A person's need for insurance changes dramatically through their lifetime. Refer to the included graph for an illustration of the different components to consider. Life insurance is bought to protect the beneficiary from the financial harm of the death of the insured. As children, we need life insurance the most, since the death of our parents can leave us without financial support. To know how much life insurance you need to buy, ask yourself how much your dependents will need to carry on without you. Will your spouse need to hire help for the business, kids or home without you? Will your children be able to go through college? Will your parents be able to afford their medical bills? This number changes as you age, as illustrated by the yellow.
The typical formula given is to multiply your yearly income by five. This will generally allow your family to absorb the immediate impact of your death without drastic change in their lifestyle. By this formula, people without an income do not need to buy life insurance. Don't forget to include the economic impact of a person's life as "income." Stay at home parents are often under-appreciated in this regard. Child care and housekeeping may not show up on your tax return, but try replacing them to see their true value. Sometimes, the impact of a person's death is not just loss of income. Funeral arrangements and other costs associated with the death of a loved one or even business partner can be significant.
The yellow only takes into account the pure risk need for life insurance. Everyone, regardless of income level, should make sure that this amount is covered by term insurance at a minimum. People with higher income levels benefit from the tax advantages of life insurance. As the blue illustrates, this typically rises as a person ages and has more of an estate to shelter from inheritance taxes. This type of need is better served by permanent life insurance. To calculate your exact need, you should contact a qualified financial planner, not an insurance agent.
Because of the bump in the curve, it may be advisable to buy a certain amount of permanent life insurance and cover the rest with term insurance. That way, you get the benefits of permanent life insurance for the amount you will still need when your children no longer depend on you.
Comments