Life insurance is not a topic many people like to discuss. Nearly half of adults don’t even have a life insurance policy. That’s how many don’t currently have any life insurance. Granted, many of these adults are young and single – just out of college or starting out in their careers – so it’s difficult for them to conceive of any reason they should own life insurance.
For the half of adults that do own life insurance, their reasons are clear. Having a financial security blanket to protect their family from financial hardship is the primary reason for owning life insurance. While that checks off the more practical reasoning, most people buy life insurance out of their devotion and sense of responsibility to the ones they love – more of an emotional purchase that brings peace of mind to the family.
Other key financial objectives for people who buy life insurance include:
For the millions of adults who don’t own life insurance, they may have their reasons why they don’t. It can’t be about the cost because life insurance has never been more affordable. While young adults may not have an emotional need, nor an immediate financial need for life insurance, there are plenty of reasons why they should consider it.
The cost of life insurance is mainly based on your age. With each passing birthday, the cost goes up. Young adults have the opportunity to lock in a low premium for their entire adult lives. Chances are, you’re going to buy life insurance at some point – when you marry or start a family – so why not save yourself hundreds of dollars a year by buying it when it is most affordable?
Studies show that more than half of young adults will develop some sort of health condition, making it difficult for them to qualify for life insurance in the future. Typical age- or family-related maladies include high blood pressure, high cholesterol, diabetes, and many other common diseases. When that happens, the cost of life insurance can become prohibitive if they can qualify for it. The time to buy life insurance is when you are at your healthiest because it will never be cheaper.
Many adults opt to join their employer’s group life insurance plan thinking they’ve covered their obligations. However, on average, adults will change jobs every five years and their group life insurance coverage doesn’t go with them. There is a chance their next employer won’t offer group coverage. For those who continue with group coverage, at some point, it won’t be enough to cover their actual life insurance need because the coverage is limited.
Buying life insurance is as much about protecting your insurability as anything else.
If you have normal life aspirations of getting married, having kids, buying a home, and leaving a legacy for your kids, life insurance plays a critical role in your financial planning. As mentioned above, the best time to purchase life insurance is when you’re young and healthy. However, if you’re like most people, your impetus to buy life insurance will be triggered by any number of milestone events, such as marriage or starting a family.
The need for life insurance is dictated by your circumstances:
If you’re serious about financial planning and achieving your life’s ambitions, it’s often difficult to achieve that plan without life insurance in most circumstances.
You probably need more life insurance than you think. There are several ways to determine how much life insurance you need, from general rules of thumb to having your financial advisor do a thorough needs assessment.
Multiple of your income: A popular rule of thumb is the income multiple approach. Depending on your age, family size, and your family’s lifestyle needs, your death benefit should equal a multiple of your income. Most planners recommend a multiple of ten times your income (i.e., $100,000 of income = $1 million death benefit). Then add $100,000 for each child’s college education. If you’re younger, the multiple should be higher than if you’re older.
You can arrive at a more accurate need by using the simplified DIME method:
Debt: Your family shouldn’t be saddled with debt. Add your total debt, including credit cards, personal, and auto loans. If you have a federal student loan, it will be discharged at your death as your estate is not responsible for paying it off.
Income: If you are the primary breadwinner, you will need enough coverage to replace your income. This should amount to enough income to keep your family in their home and the lifestyle they’ve come to enjoy. If your spouse doesn’t work or earns a significantly smaller portion of the household income, the amount should be higher than if they are co-equal breadwinners. If your kids are younger, the income replacement should be higher than if they are older (closer to the age of majority or through college).
Mortgage: Your home is your biggest asset, and your mortgage is your largest debt. If you should die, you want your family to keep the former by getting rid of the latter.
Education expenses: If your goal is to have your kids attend college, you will need sufficient funds to pre-pay their expenses.
You’ll also need to cover your final expenses, including medical and burial costs. It’s recommended to set aside $25,000 to $40,000.
Generally, your life insurance need will decline over time. The amount of coverage you need now is far more significant than what you will likely need in 20 years.
Professional life insurance assessment: For the ultimate piece of mind knowing you have the right amount of coverage, you should consider having your financial advisor perform a professional needs assessment. They utilize sophisticated calculators that account for your current and future income and cash needs, growth of capital, social security integration, and inflation.
Generally, life insurance policies have two categories—term and permanent. Within each category are several subsets or variations.
You can think of term insurance as a bare-bones death benefit for which you pay a premium to cover the cost of insurance for a period of ten years up to 30 years, which is why it’s more inexpensive than permanent insurance. There are several subsets of term insurance designed for different needs or preferences.
Term life insurance is best suited for people who want to own life insurance as cheaply as possible. It may not be suitable for people needing coverage beyond 20 or 30 years.
Yearly Renewable Term (YRT): YRT is the most basic form of life insurance. Your premium is pegged to your mortality costs which increase each year. While your premium increases each year, your death benefit remains level. YRT is most suited for people who want the most coverage for the least amount of money. The caveat is that, eventually, the premium cost can become prohibitively expensive if you still need the coverage in your fifties or sixties.
Level Term: This policy also provides a level death benefit, but its premium payments are level and fixed. The premiums are generally higher than YRT initially, but as you age, the level premium is typically lower than the YRT premium in later years. Level term is best suited for people who want predictable premiums and may have a more prolonged need for coverage.
Decreasing Term: With this policy, the premium remains level, but the death benefit declines over time. A common use for a decreasing term policy is to cover a mortgage balance, which also decreases over time.
Permanent insurance is a form of life insurance that builds equity over time. As long as premiums are paid, a permanent policy is guaranteed renewable and guaranteed to pay off. The death benefit is level, as are the premiums. But, instead of covering just the insurance costs, a portion of premiums contributes to a savings element of the policy.
The savings element accumulates a cash value. As the cash value grows, the mortality costs decrease because it reduces the amount for which the insurer is at risk. That’s how they are able to calculate a level premium. Available cash value may be used for other planning needs, such as funding college education or retirement.
The subsets of permanent insurance include:
Whole life: Level premium, level death benefit. Guaranteed cash value growth. Some whole-life policies pay a dividend which can be used to reduce the premium or increase cash value growth. Whole life is most suited for those who want absolute guarantees for their life insurance.
Variable life: Level premium, level death benefit. Instead of guaranteed cash value growth, the savings element is comprised of various investment accounts similar to mutual funds, which might include a guaranteed account. Variable life is most suited for those who prefer to take some risk to earn higher returns on their cash value.
Universal life: Flexible premium, flexible death benefit. Cash value growth is tied to a current yield, which is fixed for a year or more and becomes variable. There are also variable universal policies with investment accounts instead of a fixed yield. Insured can raise and lower premiums based on cash value growth. Universal life is suitable for people willing to assume cash value growth risk to pay lower premiums and want more flexibility in designing their insurance plan.
Choosing between term or permanent policies should be based on many factors. Here are some factors to consider:
|● Inexpensive life insurance||● Coverage is temporary|
|● You pay only for the death benefit||● Premiums can be prohibitively expense if coverage is needed in later years|
|● Guaranteed renewable if premiums are current||● No cash value accumulation|
|● Can ladder policies to extend coverage at least cost|
|● Can be converted to a permanent policy|
|● Guaranteed premiums and death benefit||● Initial premium significantly higher than term|
|● Cash value element can lower long-term insurance costs|
|● Cash value grows tax deferred|
|● Cash values may be accessed tax free via policy loans|
|● Cash value is returned if policy is cancelled|
When you purchase life insurance, you enter into a contract with a life insurer who, in exchange for a premium, promises to pay your beneficiaries a death benefit when you die. However, their guarantees are only as solid as the company’s financial strength. Life insurers are among the most financially stable financial institutions with strict reserve requirements. Still, working with the most financially sound companies is advisable to reduce any possible risk.
Companies rated A+ by A.M. Best are considered to have a superior ability to meet their financial obligations. A-rated companies have an excellent ability to meet their obligations. Companies with a B or B+ rating have a good chance of meeting their commitments. Below that, companies are considered marginal or weak in their abilities to meet their obligations.
So, that’s where you should start in comparing life insurers. From there, you can compare insurers and their products using any number of online comparison sites.
Alternatively, you can work with your financial advisor to help you assess your coverage needs and select a life insurer that best fits your needs and circumstances. At Dechtman Wealth Management an advisor can provide you with a thorough assessment of your life insurance needs based on your financial plan. Because we have access to several top life insurers with quality products, we can objectively match you with the right one for your situation.
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