On the list of financial preparedness, the least favorite topic may be having adequate life insurance. For most folks, they put the topic off until the midnight anxiety session that arises near the homecoming of their first child. And given that fear or anxiety doesn’t always lead to the best decisions, many may be asking, did I get it right? For those who worry about how much, how and when to proceed, this primer may help.
First, let’s talk about the basics of a life insurance policy. Just like any other insurance policy, a life insurance policy is a contract with an insurance company that in exchange for your payments they agree to provide a payment to your beneficiaries on your death. That payment is usually all at once, or sometimes called a lump sum payment. The beneficiaries are those who you named in the original policy. If you initially named a person, say your spouse, to receive the benefits and now wish to change that, say that person is no longer your spouse, you’d need a rider to the original agreement. Usually, your beneficiaries are not taxed on the payout. For many people, life insurance payments can become a way of transferring wealth during their lifetime to their beneficiaries at their death in a manner that incurs less taxes.
There are two main types of life insurance: term and permanent. Term life insurance provides insurance for a set period of time, say 25 years, whereas permanent insurance covers your entire life. Term life insurance has a set premium that is usually lower than permanent life insurance. This is often chosen as it helps ensure that financial goals, like sending kids to college or paying off a mortgage, could be met if your income were to be taken away. Term life insurance comes in a variety of forms, including increasing and decreasing. Permanent insurance also comes in a variety of forms.
Unlike term life insurance, universal life insurance covers your entire life. Because your risk of death changes as you get older, the premiums increase as you age. Premiums are set by a variety of factors, but usually focus on your health, family medical history and your lifestyle.
Whole life insurance coverage is another kind of permanent life insurance. It also has higher premium payments. This kind of insurance has a cash value and can accumulate over time, which could have a savings component to it. It too is often used as an estate planning tool to help transfer wealth to your beneficiaries.
How much life insurance do you need?
That depends on how well prepared your spouse or family is to handle your loss of income in retirement if you pre-decease them. Many couples plan for retirement based on a dual income in retirement. For those with investments or pensions, losing a spouse may be less harsh financially than for those dependent on social security income which could terminate on your death. Life insurance amounts should be set to keep income protection for the surviving spouse in mind. So too amounts should be set for children and college educations, as noted in the term life insurance discussion.
When you acquire the life insurance policy may be the wrong question.
The kind of policy you obtain may be driven by your age more than anything else. At a younger age, with less disposable income, a term policy may be the best option. As you age and gain more disposable income, and more people become dependent on you, you may need to change from term policies to one with a cash value or one that protects whole life. The best time to start a life insurance policy is now. Which life insurance policy is the crucial question for which you may need tax and estate planning advice. Where you obtain life insurance may be driven by the kind and amount of life insurance you’ve decided to acquire.