Life insurance is a key component of your family’s estate plan. It offers those who depend on you for their financial security a safety net in the event of your untimely death. Whether those dependents include your spouse, children, aging parents, business associates, or all of the above, investing in life insurance is a way to say “I love you” and make certain that when you pass away, the people you love will have a reliable source of financial support to count on.
Although purchasing life insurance may seem straightforward, it can be quite complex. There are a myriad of coverage types available along with riders, premium payment options, and terms and conditions to consider. Not to mention the insurance agents who are incentivized to sell specific products regardless of whether they actually fit your needs. This can make it challenging to determine exactly how much coverage (and what type of insurance) you need—and who you can trust to give you objective and accurate advice about that coverage.
With this in mind, we will break down the common types of life insurance coverage, explain how each of the different types work, and outline what you need to know in order to purchase a policy that will adequately address your needs, objectives, and family situation. Here are a few of the most important factors to consider when shopping for a life insurance policy.
Betting On Your Life
The earlier in life that you purchase your policy, the less expensive your monthly or annual premiums will be. Investing in life insurance early on also means that you will pay into the policy for a longer period of time. Most insurers will require some type of health evaluation before issuing a policy. Typically, the healthier and younger you are when you get life insurance, the less you will pay in premiums.
A life insurance policy is basically a bet between you and the insurance company about how long you will live. The insurance carrier is betting that they will be able to earn enough from the premiums you pay during your life, so that they will have received more than enough money to pay out the death benefit to your designated beneficiaries by the time you pass away.
Life insurance comes in two main forms: permanent and non-permanent. With permanent coverage, such as whole life and universal life, as long as you pay the premiums, your insurance cannot be canceled, and your policy will be there and pay out when you die (unless you live longer than the guaranteed period). If you live longer than the guaranteed period (in most cases age 100), the death benefit will be paid out to you at that age (this can vary- confirm with your agent how your specific policy works).
With non-permanent coverage, known as term life insurance, you pay premiums over a certain number of years—usually 10, 20, or 30. If you outlive the term of your policy, the insurance will end unless you are reevaluated and issued a new policy at a higher rate. Group policies through an employer are also a type of term policy. They are generally only in force while you are with that employer and lapse when you leave.
Permanent vs Term Life Insurance: Which Do You Need?
To determine which type of life insurance policy you should purchase for your family, you will need to consider a number of factors. Life insurance is a must if any of the following four scenarios apply:
- You have dependents—minor children, a non-working spouse, or senior parents—who rely on you for their financial needs, and you will not have enough saved up at the time of your death to provide for their needs for the rest of their life.
- You have a business that will need a cash infusion to keep it running, until it can be sold or for your loved ones to buy out a business partner.
- You will have an estate tax bill that you want to make sure is covered by life insurance so your family is not forced to sell assets to pay your estate taxes.
- You carry a significant amount of debt obligations and lack the liquid resources to pay them off. In each of these situations, you want to make sure you have either term life insurance that will continue long enough to cover your needs, or you may want to consider purchasing permanent coverage.
Term Life Insurance
The coverage periods of term life policies can vary widely: 10, 15, 25, 30 years, or longer. Because your coverage expires after a certain number of years, term life insurance is a lot less expensive than a permanent policy. Term policies are typically used by people who expect that they will only need the insurance for a certain period of time or for a certain purpose.
For example, I purchased a certain amount of term life insurance that would cover my children until I felt like they would reach full independence, plus an amount of permanent life insurance that I felt would be sufficient to take care of things no matter when I pass away. You might purchase term life coverage to pay off your home mortgage. You might also have minor children who rely on your income for their basic needs, and want a term policy to ensure they have enough money to live on until they become financially independent. You may even take the road that I did and combine the two types of coverage. It really just depends on what you feel your family will need when they no longer have your income or future earning potential.
Permanent Life Insurance
Permanent life insurance comes in many different forms. Some of the more popular types are whole life, universal life, and variable universal life. In many cases, permanent life insurance is used for estate tax planning, very high-end income tax planning, and can also be used as key-person insurance for businesses. The various forms of permanent life insurance typically pay a death benefit whenever you die, no matter how long you live (unless the policy contract has a termination provision at a specific age).
Permanent life insurance policies typically have two components: the amount that goes toward paying for the life insurance, and the amount that builds up as an investment, called the “cash value” component. The cash value amount of your premium is invested tax-free, and depending on the policy, you may be able to use the cash value component in several ways: You can borrow against it throughout your lifetime (in which case you pay interest to the insurance company), you can take out cash withdrawals (in which case your death benefit would be reduced accordingly), or you can use it to pay future premiums (use this option with caution to avoid any lapse in coverage if cash value is insufficient to cover premium).
There are some caveats to mention here: You often need to pay premiums on a permanent life insurance policy for a significant amount of years (at least 10) before there is enough cash value to borrow against or use to pay premiums. If you access the cash value of your life insurance, you will reduce your death benefit, and you also may have to pay fees or taxes, depending on the policy and how much you take out. If you withdraw too much your coverage could terminate.
Keep in mind that life insurance is for providing your loved ones with a death benefit when you die, so you should always consult with your estate planning attorney and financial advisor before accessing the cash value funds.
How Much Life Insurance is the Right Amount?
When purchasing life insurance, you will want to make sure you have enough term life insurance to cover the expenses that your dependents will require until they are no longer dependents, or until you are certain that you will have enough money saved up to cover the lifetime needs of those dependents.
If you have children with special needs, a non-working spouse or are a single parent, your dependents will require a longer period of care after your death, compared to a family with two incomes and children who will achieve their own independence in their late 20s or early 30s. To determine the right amount and type of life insurance for your unique situation, consult with us, your Life & Legacy Attorney for an objective analysis.
Your Trusted Advisor
We all have unique assets, liabilities, and family situations, so there is no way to know exactly what types and amounts of life insurance coverage your family needs without a full evaluation. Before you sit down with an insurance agent, meet with us, your Life & Legacy Attorney, to identify the appropriate life insurance policy for your particular situation. Schedule your appointment today to get started: Schedule now.
This article is a service of Reflections Life Planning LLC, Personal Family Lawyer®. We do not just draft documents; we ensure you make informed and empowered decisions about life and death, for yourself and the people you love. That’s why we offer a Family Wealth Planning Session™, during which you will get more financially organized than you’ve ever been before and make all the best choices for the people you love. You can begin by calling our office today to schedule a Family Wealth Planning Session and mention this article to find out how to get this $750 session at no charge.