Life Insurance: The Vegetable of Your Financial Diet
September is Life Insurance Awareness Month, which made me think of our diets. Stay with me here. When it comes to our nutrition, we know that sweet treats tempt us with their deliciousness, but we also know that they can divert our attention from the nutrient rich vegetables that contribute to our health and overall well-being. So too with a hyper-focus on investments, which can push aside core elements of our financial health, like life insurance.
Why is life insurance so important? Because it is one of the few financial products that can solve a future problem easily. The core concept is simple: you agree to pay a certain amount of money to an insurance company (the premium), and in exchange, the company will pay out a lump sum or sometimes a stream of payments (a death benefit) to your designated beneficiaries in the event of your death.
Unlike vegetables, not everyone actually needs life insurance. One quick way to determine if you do, is to ask yourself a basic question: If I were to die now, would anyone suffer financially? Many people may focus on their young children or spouse, but if you are providing support to adult children/grandchildren, siblings, older parents; if you own a small business; or if a large portion of your net worth is tied up in an illiquid asset (think real estate), you may need coverage. If you are the primary caretaker of your child, and your spouse is the money maker, you too may need insurance because it will cost a lot to hire replacement child care and/or your spouse may want to have the ability to step back from work in order to be at home with the kids.
If you do need life insurance, the price depends on your age, your health, the type of policy you choose, and how much insurance you buy. To determine the amount, think about what you would like to cover in the future. In addition to setting aside money for the funeral and ongoing living expenses, do you want to plan to pay off an existing mortgage or car loan and do you want to fund future expenses like college costs for kids or a surviving spouse's retirement needs?
With those questions answered, turn to a free online calculator, where you will be prompted to plug in the variables that apply to you, like how much money you spend monthly, how much you have already saved, how much coverage is already in place (don’t forget your workplace plan), and the amount of debt you want to pay off.
Once you have an idea of the amount, the next question is what kind of insurance is best for you. The two categories are term and permanent life. Let’s start with term, because most people have a specific insurance need for a defined period, a term of 10 or 20 years. After that time, the need for insurance may be reduced, either because circumstances have changed (kids are older and launched, debts have been paid down) or because you have saved and invested enough money to cover whatever needs still exist. Because coverage remains in place for a specific number of years, the cost of term is usually affordable if you are mostly healthy.
To shop for term insurance, start with your employer’s benefits. Many companies offer term life that is equal to a multiple of salary, with an opportunity to purchase additional coverage beyond the base amount. If that extra coverage is portable (meaning you can take it with you if you were to get another job), it is worth considering buying for you and/or your spouse. Otherwise, go online to find competing quotes.
For those who need coverage for their entire lives, perhaps for estate planning purposes, to fund a special needs trust, or to facilitate small business buy-sell agreements, term is not going to cut it. Instead, you would look at permanent life insurance (whole, adjustable, and universal) which remains in place until you pass away. Because this is coverage that could last decades in the future, it is more expensive. Permanent policies also have savings or investment components, but that’s not why you should be buying them. If you are getting a hard sale for permanent coverage, consult a fee-only financial advisor, who can evaluate your needs, determine the right type of policy, and refer you to a reputable agent, if the more expensive coverage is warranted.