Life insurance is a key component of your family’s estate plan, offering those who depend on you for their financial security a safety net in the event of your 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 fairly straightforward, it can actually be quite complex, especially given all of the different types of coverage available. It can be challenging to determine exactly how much coverage (and what type of insurance) you actually need—and who you can trust to give you objective and accurate advice about that coverage.
With this in mind, we’ll 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 begin discussions with a financial advisor about purchasing a policy that will adequately address your needs, objectives, and family situation. While you should always meet with your Personal Family Lawyer® and financial advisor to ensure you get the proper coverage, here are a few of the most important factors to consider when shopping for a life insurance policy.
Betting On Your Life
Depending on the type and purpose of your coverage, a life insurance policy pays benefits to your family or business (whomever you choose as the beneficiary) in the event of your death. And while you may not need it until you die, the earlier in life you purchase your policy, the less expensive your monthly or annual premiums will be. Of course, investing in life insurance early on also means that you’ll pay into the policy for a longer period of time.
By the same token, the healthier you are when you get life insurance, the less you’ll pay in premiums, because your policy is basically a bet between you and the insurance company about when you’ll die. The insurance carrier is betting they’ll be able to earn enough from the premiums you pay before you die, so that they’ll have received more than enough money to pay out the death benefit to your designated beneficiaries by the time you pass away. To that end, many carriers require a medical exam before you are issued a policy.
Life insurance comes in two main forms, which you can think of as permanent and non-permanent. With permanent coverage, such as whole life and universal life, as long as you pay the premiums, your policy will be there so it can pay out when you die (unless you live longer than the guaranteed period).
With non-permanent coverage, known as term life insurance, you pay premiums over a certain number of years—usually 10, 20, or 30—and if you have not died during that period, the insurance ends, your premiums are gone, and no benefits are paid out when you die (unless you buy more term at that point or are able to convert the policy to permanent).
Permanent vs Term Life Insurance: Which Do You Need?
To determine which type of life insurance policy you should purchase for your family—permanent or term—you’ll need to consider a number of factors. When it comes to buying life insurance for your family, you will need to die with life insurance coverage in place if any of the following four scenarios apply:
- 1. You are likely to 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.
- 2. You have a business that will need a cash infusion if you die to keep it running, until it can be sold or for your loved ones to buy out a business partner.
- 3. You have debts and you want your family to have readily available cash to pay them off at the time of your death instead of having to use up your hard-earned savings, investments, or other assets.
- 4. You will have an estate tax or other death tax bill that you want to make sure is covered by life insurance so your family doesn’t have to sell assets to pay your estate taxes.
While the above list does not include every possible use of life insurance, these are common scenarios where life insurance is desirable. 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’ll 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 much cheaper than permanent. Term policies are typically used by people who expect that they’ll only need the insurance for a certain period of time or for a certain purpose, but at some point in the future, they will no longer need the coverage.
For example, you might purchase term life coverage in order to pay off your home mortgage in the event you die before it’s paid off. Or you might have minor children, who rely on your income for their basic needs, and you need a term policy to ensure they have enough money to live on until they become financially independent should you die before they reach adulthood.
Permanent Life Insurance
Permanent life insurance comes in several different forms, such as whole life, universal life, variable universal life, and survivorship policies. And it’s often times used for estate tax planning, as well as high-end income tax planning, and can also be used as key-person insurance, which pays out benefits if you fill a vital role in a company that would need cash upon your death to continue operating. As mentioned earlier, the various forms of permanent life insurance 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 interest is paid to the insurance company), you can take out cash withdrawals (in which case your death benefit could be reduced accordingly), or you can use it to pay future premiums.
There are some caveats to mention here: You often need to pay premiums on a permanent life insurance policy for several years 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 could reduce your death benefit, and you also may have to pay fees or taxes, depending on the policy and how much you take out. And if you withdraw too much, your coverage could terminate.
Keep in mind the reason for which you purchase the life insurance and always consult with your estate planning attorney (which is preferably us, your Personal Family Lawyer®) and a financial advisor, before accessing the cash value funds.
How Much Life Insurance is the Right Amount?
When purchasing life insurance, you’ll 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 or a non-working spouse, they 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 of term life insurance, consult with us, your Personal Family Lawyer® and a comprehensive financial advisor.
If you own a business and plan on staying in your business well beyond the typical retirement age, if you are an important part of your company’s continued success, or you will have estate taxes to cover upon your death, you should consider permanent life insurance. In that case, you’ll want to consult with us, as your Personal Family Lawyer®, and an insurance agent (who may also be your comprehensive financial advisor) to make certain you understand the terms of the policy you are buying and why you are buying it.
Your Trusted Advisor
We all have unique assets, liabilities, and family situations, so there’s no way to know exactly what types and amounts of life insurance coverage your family needs without a full evaluation. Meet with us, your Personal Family Lawyer® and we will have a confidential discussion with you and your financial advisor to identify the appropriate life insurance policy for your particular situation. If you do not have a comprehensive financial advisor, please let us know and we can help you identify one at no additional cost to you. Schedule your appointment today to get started.