If you’re just getting started in your adult life, there’s a good chance you haven’t given much thought to life insurance yet. But if you have anyone who is financially dependent on you (like a spouse or kids), then you really need to learn about life insurance and make sure that you have the proper insurance in place.
What is life insurance?
Life insurance is an agreement between you and an insurance company to pay money in exchange for receiving a death benefit if you die or after a set period.
What is the purpose of life insurance?
The purpose of life insurance is to protect your dependents against the loss of income if you die. It’s to protect anyone who would suffer financially from your death.
Who needs life insurance?
If anyone would suffer a financial loss if you died, then you need life insurance.
You need life insurance if: You have children
Everyone who has children needs life insurance! Your children would financially suffer if you died. To protect them financially, you should have life insurance in place.
You need life insurance if: You have a spouse
If you and your spouse are child-less but you both work and contribute to pay the bills, you need life insurance to cover the cost of living if one of you should die. However, if you are child-less and one of you does not work, the non-working spouse would not need life insurance.
You need life insurance if: You are a stay-at-home parent
Most people forget that it’s important to have life insurance on the non-employed, stay at home parent. If the stay at home parent dies, the working parent will have to pay someone to do everything the stay at home parent did (and it will cost a lot).
You need life insurance if: You have a private loan with a cosigner
If you have a private loan with a cosigner, you need life insurance because upon your death, your cosigner will be responsible for paying the loan, in full.
Who does not need life insurance?
If no one is dependent on you financially, then you do not need life insurance.
You do not need life insurance if:
– You are a young, single person without any private loans
– You do not have kids or any other dependents
– Basically, if no one would suffer from your death financially, then you do not need life insurance.
If you need life insurance, what type should you get?
There are a several types of life insurance options, but there are basically two categories of life insurance: term and cash value.
Term insurance is only insurance (not a savings vehicle; you just pay for your insurance and that’s it). You pay a monthly premium in return for a lump sum payment if you die during the length of the term. If you don’t die, at the end of the term, you get nothing. It’s good for a number of years and after the term, it goes away. As you get older, it costs more to have term insurance. The policies are usually inexpensive at first, however (about $25-35 / month).
There are two over-arching types of cash value insurance: universal and whole (each has several spinoff options). With cash value policies, you pay higher monthly premiums in exchange for permanent lifetime coverage. Cash value is about 20 times more expensive than term insurance! Cash value life insurance has a tax-deferred savings component.The money above and beyond your insurance premium goes into a savings account. This sounds great, but the savings vehicles that you are quoted end up not being that great due to all the fees that insurance companies charge. Your rate of return on an average universal policy is 4.7%! This is not a good long-term investment. Further, when you die, the company pays the face value of the policy. The money you saved, at 4.7%, is kept by the company. So, the savings account has a low rate of return and when you die the company keeps your money!
With a universal plan, you pay a higher monthly premium in exchange for a long period of coverage, usually for permanent lifetime coverage, but you can set the period of time and the benefit. Your premiums may increase or decrease throughout your life. Universal policies include a tax-deferred savings vehicle, like whole life policies. Whatever is invested, you can cash in or borrow against. Universal life insurance offers more flexibility than whole life, allowing you to increase or decrease your death benefit, for example.
I do not like whole life or universal life insurance, in general (especially for young, healthy people). I believe insurance should be used for insurance purposes and it’s best not to try to make an insurance vehicle a savings vehicle. Typically, the return on your investment is not good — you are better off actually investing that money in the market instead of an insurance policy. There may be reasons for getting a whole life or universal policy now if you think you won’t be insurable later. Talk to your financial professional to determine what’s right for you. But make sure your financial planner is fee-only when you do this. If she is fee-based or commission based, then she may actually try to see you one of these policies. Fee-only financial planners have a fiduciary duty to act in your best interest (learn how to pick a financial planner).
I recommend using a site like PolicyGenius to search for the right term insurance for you (it’s fast and easy).
How much life insurance do you need?
You need enough life insurance to cover your dependents’ financial needs for the next 10, 20, or 30 years, depending on their age. The critical question is: how much income would your dependents need if you died?
To determine a rough estimate of how much life insurance you need, do the following calculation.
- Determine your after-tax, take home, yearly income. This is the amount of after-tax income your dependents will need if you die.
- Divide your take home income by an approximate rate of return (such as 5%).
- This equals the lump sum your dependents need if you die, and is thus how much life insurance you should have. After receiving this lump sum, your dependents should invest it, which will yield yearly income they need.
Take Home Income / Rate of Return = Insurance you need
For example, if you take home $50,000 per year (and that’s what your dependents will need if you die), divide $50,000 by 5%. Here, you would need a $1,000,000 term life insurance policy (50000 / 0.05 = 1000000). Your dependents then invest the $1,000,000 at a rate of 5%, which will yield $50,000 / year for 20 years.
Where should you buy life insurance?
Instead of buying from an agent working for a specific company, look at online quoting service and buy the cheapest quote, like PolicyGenius.