Choose Life Insurance
Life insurance is part of estate planning. If you have loved ones who depend upon you financially, you need life insurance. A life insurance policy allows your beneficiaries to cover their living expenses after your death. Depending on the size of the benefit you want to provide and the amount you can afford to pay on premiums, you can choose from several different types of life insurance policies.
Calculating How Much Life Insurance You Need
- Decide whether or not you need life insurance. If you have anyone who relies upon you financially, then you should purchase a life insurance policy. You may be able to purchase a life insurance policy through your work. But the coverage may not be high enough, and it likely only remains in place while you are employed. Depending on the amount of coverage you need, you may need to purchase an additional life insurance policy outside of work.
- If you are single with no dependents, you probably don’t need life insurance. Similarly, if you have recently gotten married, unless you own any property, you may not need life insurance.
- However, some people in this case purchase a small policy. This would allow loved ones to cover their final expenses such as burial and funeral expenses.
- Estimate your family’s living expenses. If you are responsible for providing some or all of your family's living expenses, you will want to buy insurance to cover this amount so that your family can live securely after your passing. Add up your take-home income over a year and then multiply that number out for a number of years to determine an insurance amount to purchase. This time period is not set in stone and will depend on how much insurance coverage you want to purchase and how much will make you feel that your family could live safely in the event of your passing.
- Another consideration is the cost of child care. If you pass, a stay-at-home spouse may be required to work, which would also require them to pay for child care for your children. Add in this expense to your total amount.
- Add up your debt balance. Determine how much money it would take to keep your house, such as the amount you still owe on your mortgage. Tally up any unpaid debt in addition to your mortgage. Your family will be responsible for your car loans, student loans and credit card debt. Add in your final expenses. Your family will have to pay your medical bills and funeral expenses, and they may need to pay estate taxes.
- For example, suppose you owe $150,000 on your mortgage, and you have other consumer debt that adds up to $20,000. Estimate that your final expenses will cost $5,000. This adds up to $175,000 <math>($150,000 + $20,000 + $5,000 = $175,000)</math>.
- Consider your children's education. You want to leave your family with enough money to cover future financial obligations. For example, your spouse may want to send your children to college. Estimate how much would be needed for tuition, books, fees and room and board. If you pass away, this might not be possible without your income. A life insurance policy can make it a reality.
- For example, if you want your children to be able to attend an in-state, four-year public school, you will need to have at least $130,000 per child. If you have three children, you would need $390,000.
- Add up the current financial resources. Tally up any financial resources still available to your family after your death. For example, your spouse may have an income. You may have savings or retirement accounts. In addition, you may have begun saving for college. Also, you might have other life insurance policies. Add up the balances in all of your accounts.
- For example, suppose you have $75,000 saved in your retirement accounts and $10,000 saved for college. Also, you have another life insurance policy through work that’s worth $50,000. That means you already have $135,000 in financial resources <math>($75,000 + $10,000 + $50,000 = $135,000)</math>.
- Calculate how much life insurance you need. Add up all of the expenses you want to cover, including paying off your house, paying off your debt and sending your children to college. Add up all of your financial resources, including your retirement savings, college savings and other life insurance policies. Subtract the value of your financial resources from the total expenses you want to cover. This tells you how much life insurance you need.
- In the above example, you want to cover $175,000 in debt and $390,000 in college tuition. This totals up to $565,000.
- You already have $135,000 in other financial resources.
- You need to purchase $430,000 in life insurance <math>($565,000 - $135,000 = $430,000)</math>.
- Use an online life insurance calculator. Many life insurance companies have online forms that will help you figure out how much life insurance you need. You enter in how much outstanding debt you have and how many children you need to send to college. You also input information about the total annual income your family would need and any income you expect your spouse to earn after you die. Once you submit the information, the calculator analyses your situation and tells you how much life insurance you need to purchase. From there, you would contact an agent and discuss the life insurance products they have available to cover your needs.
- Re-evaluate your insurance needs when you reach retirement age. If you have purchased a term life insurance policy, it has likely expired by the time you reach retirement age. At this point, the cost of purchasing a new life insurance policy would be prohibitively high because of your age. If you have planned well for retirement, however, you shouldn’t need a life insurance policy. Your retirement accounts should be able to provide for your loved ones in the event of your death. Similarly, if you have a cash-value policy, you shouldn’t need that anymore either. Cash out the policy and add the cash value to your retirement accounts.
Understanding Life Insurance Products
- Compare term life and whole life insurance. These are the two basic categories of insurance available. Term insurance is good for a specific period of time, whereas whole life insurance is good for your entire life if you the pay the premiums. Term insurance is typically inexpensive, and whole life insurance is pricey. This is because term insurance is pure mortality risk, administrative costs, and commissions while whole life is mortality risk, an investment portion, administration, and commissions. The difference is the investment piece on the latter. This means that whole life insurance policies set aside a portion of the premium you pay each month to be invested and grow in value.
- Term life insurance is basic and inexpensive. It is good for a specific amount of time. For example, your term life insurance may cover your for 10, 20 or 30 years. If you die during the term of your insurance, your beneficiaries get your death benefit. If you die after the term has expired, your beneficiaries get nothing.
- Whole life policies are also known as cash-value policies. They are good until you stop paying premiums. They do not expire after a certain number of years. Also, they have an investment component attached. This means that part of the premium is invested by the insurance company and earns interest. Three types of whole life insurance are whole life, universal life and variable life.
- Life insurance policies should provide you with enough to provide financial support to your family in the event of your death. While having a cash value policy that grows over time sounds attractive, this option can be expensive. If you would be struggling to pay the premiums on such a policy, then term insurance might be the best option for you.
- However, if you can afford the premiums and you have maxed out your contributions on your pre-tax retirement accounts, a cash-value life insurance policy might be a good choice for you. Since the cash value builds up tax free, it provides you with another opportunity to build your retirement nest egg.
- Evaluate the two types of term life insurance. You can choose from two different types of term life insurance. The first is the annual renewable term. With this type, you can purchase one year of coverage at a time. You have the option to renew each year. The other option is level premium term. This means you lock into a specific multi-year period, such as 10, 20 or 30 years.
- With annual renewable term insurance, the premium is likely to increase each year.
- With level premium term, you are guaranteed the same premium for the life of the term.
- Assess the three different kinds of permanent life insurance you can purchase. They are whole life, universal life and variable life. These policies use different kinds of investment tools to grow cash value. The rate of return, which grows cash value, depends on the risk involved in the investments. Policies with higher-risk investments do not guarantee an amount for the cash value of your policy (though the death benefit is always guaranteed).
- Whole life insurance pays a guaranteed amount to your beneficiaries upon your death. Part of your premium is invested by the insurance company to grow the cash value of your benefit. The fund grows tax-deferred each year that you keep the policy.
- Universal life insurance combines a life insurance policy with a money-market investment. This type of investment is riskier. Therefore, policyholders can expect a higher rate of return.
- With variable life insurance, the insurance policy is tied to a stock or bond mutual fund investment. The cash value account is invested in several sub-accounts. The investment grows or shrinks along with the performance of the mutual fund accounts in the market. Beneficiaries enjoy favorable tax treatments.
- Universal and variable life insurance may offer higher returns than whole life insurance, but they do not offer the guarantee that comes with whole life insurance. There is a risk that the rate of return will not be as high as expected.
- These choices differ primarily in their fixed and variable rates of interest depending upon the investment vehicle chosen. In each case, the policyholder pays a premium in excess of the actual mortality risk of the insured.
Finding the Best Life Insurance Plan
- Assess the reputability of insurance providers. Insurance providers are rated for financial strength and reputability by a handful of ratings firms. These ratings firms are TheStreet.com, Standard & Poor's, Moody's, Fitch, and A.M Best Company. Not every insurance company will have a rating with all agencies, but it is important to get ratings from each one that you can before purchasing from an insurance provider, especially if the provider is not well known. Be sure to also look into what the ratings terms mean for each rating firm.
- Firms assign ratings on different scales, with some using "A+" to denote their highest rating and others using "AAA."
- In general, an assessment of "secure" (rather than the alternative, "vulnerable") is a positive indicator of provider performance.
- Choose between term insurance and mortgage protection insurance when you buy your first house. When you purchase your first house, it is probably time to consider purchasing term life insurance. This allows the co-borrower on your mortgage to receive a death benefit that would cover any living expenses and to keep paying the mortgage. If for some reason you cannot meet the underwriting criteria for term life insurance, purchase mortgage protection insurance. This pays the beneficiary enough to pay off the mortgage on the house in the event of your death.
- Provide for your family when you are expecting your first child. Once you are expecting your first child, you need a life insurance policy to protect your family in the event of your death. Your beneficiary can use the death benefit to maintain the same standard of living for your children without having to worry about replacing your income. Choose a policy that is sizable enough to pay for at least 18 years of child-rearing and household expenses. In addition, you can provide enough to cover college tuition.
Comparing Life Insurance Quotes
- Evaluate the annual benefits and premium. Compare premiums to see if you are locked into a rate for a number of years or if it varies each year. If you are on a fixed income, a fixed premium might be better for you. Similarly, compare the death benefits. Depending on the type of policy for which you are shopping, the amount of the death benefit may not be guaranteed. Evaluate how much it is likely to fluctuate each year.
- For example, term life insurance policies are less expensive than permanent life insurance policies. Their premiums are fixed, meaning you pay the same amount each month for as long as you have the policy. Also, the death benefit is a guaranteed amount. Your beneficiaries are guaranteed to get the amount of insurance you purchased.
- Permanent life insurance policies are more expensive. Also, some invest part of your monthly premium in order to grow the cash value of your policy. This means that your monthly premium might vary. It also means that the amount of your policy's cash value is not guaranteed (though your death benefit is). It can increase or decrease depending on how well your investments perform.
- Calculate the amount of cash value you can accumulate. If you are shopping for a cash value policy, determine how much the cash value can grow. Whole life, universal life and variable life policies utilize different kinds of investment tools. Depending on the risk involved, the rate of return varies. Cash value is important for when you do not die.
- Speak with your insurance agent about the kinds of investment tools they will use and how risky the investments are. The riskiest investments have the potential for high rates of return. This means the cash value can grow quickly. But, they also can crash just as quickly, depleting your investment. This means that the amount of death benefit paid to your beneficiaries decreases.
- Decide how comfortable you are with the different levels of risk before settling on a policy.
- Assess the fees. Some insurance providers build fees into your premiums. Before purchasing a policy, read the fine print to learn about policy fees. Policy fees mean that some of your premium is being paid to the insurance company instead of going into your death benefit. This also means that less of your premium is being invested and allowing your cash value to grow. If you are using your life insurance policy as an investment tool to build your retirement nest egg, the fees charged by the insurance company can exceed the fees you would pay to invest the money elsewhere.
- Ask if you can convert a term policy to a cash value policy. Some insurance providers write a clause into your term policy that allows you to convert it to whole life without providing new evidence of insurability. This means that you can convert the policy regardless of your health. You don’t have to undergo physical examinations in order to re-qualify. If this is something that interests you, choose a policy with this clause.
- Find out if the cash value portion of your policy has dividends. This means that you would share in the company’s surplus if you own a permanent policy. Each year, once the company has paid claims, expenses, other liabilities and has funded reserves for future benefits, it pays the excess to policyholders in the form of dividends. You can reinvest the dividends into your policy, or you can cash them out.
- This only applies to mutual companies, not stock companies, which have shareholders instead of policyholders.