When it comes to financial planning, most financial advisors today will tell you that no financial plan is complete without a bedrock foundation of life insurance. This is often true even if the client has no dependents to care for, as there may be debts that would need to be paid if the policy owner dies prematurely. But for those who have children or other dependents, having adequate life insurance is a must, and the right amount of insurance will depend upon several different factors.
Integrating Life Insurance
If you are relatively young and have small children, then you will probably need a larger amount of life insurance. If you have a special needs child or elderly parents who you are supporting, you will also want to consider a larger policy. Now is the time to obtain adequate coverage, because the cost of life insurance increases with age.
If you are in your 20s and in good health, then a large term life insurance policy will generally be available at an affordable price. This coverage can be used to financially provide for your family if something were to happen to you. The following example can help to illustrate this concept.
Let's say that you're 38 years old and you earn $80,000 a year. Your spouse stays home and takes care of your three young children. You have $45,000 of student loan debt and a mortgage of $150,000 on your home. You also have $8,000 of credit card debt that you have been paying down ever since you started your current job.
If you were to die in a car crash, what would happen to your family? Your spouse would be saddled with all of your current debt with no way to pay it unless you have life insurance.
Most financial planners would tell you that you need to have at least enough coverage to pay off all of your debts and then still have enough left over to pay for at least a few years of living expenses. This can give your spouse a chance to either join the workforce at their convenience or even remarry, instead of immediately facing a financial shortfall or current bills. And if you want to provide for your kids' college educations, then you'll need an additional amount of coverage for that as well.
Types of Life Insurance Coverage
There are two main types of life insurance, term and permanent. Term life insurance provides pure death benefit coverage at a much lower cost than permanent insurance—at least when you're young. Your employer may offer group term life coverage at a reduced cost, and this is probably the first place you should go to find the coverage you need. Just be aware of what happens to the coverage should you leave your employer. For the example above, you would probably want at least a half-million dollars of coverage to ensure that all of your debts are paid and your family still has something left over. That number may go higher if you want your kids to attend college at private schools or go to graduate school. It is vitally important that you talk with your spouse about life insurance so that both of you know exactly what will happen if something were to happen to you.
Permanent life insurance is generally much more expensive, but it is designed to last you for the rest of your life. Permanent life insurance builds up cash value in a savings account that you can access at any time for any reason. The money in the policy grows tax-deferred and any amount that is withdrawn as a policy loan is tax-free. This type of insurance can be used to pay estate taxes or other costs related to settling your estate after you die. There are many types of permanent life insurance and each has its advantages and disadvantages.
Life insurance is also important if you are the owner or partner in a small business. A life insurance policy can be used to pay off any debts incurred by the business, or it can be used in a buy-sell agreement. Under this arrangement, each partner in the business will take out a life insurance policy on each of the other partners. Then when one of the partners dies, the remaining partners can use the death benefit proceeds to buy out the deceased partner's share of the business. This can ensure the quick and smooth transition of ownership of the business in most cases.
Accelerated Death Benefits
Another key factor to consider is the accelerated death benefit riders (ADB) that are now available with many life insurance policies. These riders can pay out some or all of the life insurance policy's death benefit while the insured is still living. This will happen when the insured is either diagnosed with a major illness, such as cancer or heart disease or becomes disabled or otherwise unable to perform at least two out of the six activities of daily living (ADLs). These activities include eating, bathing, dressing, transferring (as from a wheelchair to a bed), toileting and walking.
There are four major types of ABRs:
- Critical illness (as described above)
- Chronic illness.
- Long-term care.
Not all policies offer all four of these riders, and only a few term policies offer them at all. But these riders can be a godsend for those who become incapacitated for a period of time in their later years. One of their chief advantages is that if the rider is never needed, then the cash value in the policy will still be available to use for any purpose that the insured desires. And then the death benefit will payout upon the death of the insured, although any outstanding loans from the policy will be deducted from the death benefit that is paid.
There are several good reasons to carry an adequate amount of life insurance. Consult your financial advisor or life insurance agent for more information on life insurance and the type of policy that is best for you.
How Well Do You Know Your Life Insurance?
The more you know about life insurance, the better prepared you are to find the best coverage for you.
Whether you're just starting to look into life insurance coverage or you've carried a policy for years, there's always something to learn.