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Life insurance is intended to provide those you love with financial security in the event of your death. Having adequate life insurance is a crucial part of a sound overall financial plan and can dramatically impact the lives of your survivors.
But how do you know how much you need?
You need enough life insurance to ensure that your loved ones will be able to maintain their lifestyle and meet expected expenses. Consider the role your contributions play in your family’s total budget and aim for at least enough life insurance to replace that amount for a minimum of ten years.
Read on for more about how to calculate how much insurance you need, as well as how to decide what type of insurance is right for you.
Factors to Consider When Calculating Life Insurance Needs
How much life insurance any individual needs depends on their circumstances. If you are single with no dependents, you might need only a very minimal policy with perhaps just enough to cover your funeral expenses.
However, if you have someone in your life who depends on your income, it’s important to consider what they’ll need once you’re gone.
- Is there a mortgage they’ll need to pay?
- College expenses for children?
- Do any of your dependents have special health needs?
Let’s take a closer look at these details.
Consider the Needs of Your Beneficiaries
Even among those with dependents, the need will vary greatly.
Someone nearing retirement who has significant savings and older children may need less insurance than someone younger. Additionally, the older you are, the higher the premium will be.
It’s important to weigh the cost of the policy against the needs of your survivors at their particular stage of life.
And don’t forget, not all contributions to the family budget are monetary. For example, a stay-at-home parent with no outside income needs life insurance as well. If they pass away unexpectedly, the surviving parent will need to find childcare and perhaps other domestic support.
You’ll Need to Replace Your Income for Your Family
A good rule of thumb is to start with enough insurance to replace your income for ten years, then consider other goals.
If you expect to need college funds or other big expenses, add that amount to the desired policy benefit. If you already have significant assets, it may be reasonable to deduct their worth from the amount of the benefit.
There is no one-size-fits-all rule for determining insurance needs. There are many good online calculators that can help you determine how much life insurance is appropriate for your situation.
Term vs. Permanent Life Insurance
Once you’ve determined your needs, you’ll have to choose a policy. There are two basic types of life insurance.
- Term life insurance pays a set amount as a death benefit if the insured person dies within the policy period specified.
- Permanent life insurance does not expire and typically has a savings vehicle along with a death benefit.
Which type of policy is best for you will depend on your particular needs, but there are multiple possibilities, each with its own set of pros and cons.
Types of Term Life Insurance
Basic term life insurance has a set premium and offers a range of possible terms and benefit amounts. If the policyholder outlives the term of the policy, it expires and pays nothing. If the policyholder desires additional coverage, they must apply for a new policy.
However, there are several variations on term insurance that may be appropriate for some people:
- Decreasing term insurance is sometimes referred to as mortgage term insurance. The premiums are lower than standard term insurance, but the amount of the death benefit decreases as the term continues. The idea is that most people need less insurance as their other savings increase and their mortgage balance decreases.
- Increasing term insurance is the inverse of decreasing term. It allows policyholders to pay lower premiums for a lesser benefit early in the life of the policy and increase their benefit at a higher premium when they have a higher income.
- Annual renewable insurance allows the policyholder to renew the coverage each year for a slightly higher premium. The advantage is that the renewal is guaranteed.
- Convertible insurance is term insurance that can be converted to permanent insurance without a medical exam.
Pros and Cons of Term Life Insurance
Term life insurance is the right choice for many people, as it is less expensive than permanent life insurance and can be easily customized based on the needs and budget of the policyholder.
However, it never accrues cash value, and once the term expires, all benefits, as well as all premiums paid, are gone. You can always apply for a new term policy, but depending on your age and health, the new premium might be prohibitive.
Types of Permanent Life Insurance
Permanent life insurance is exactly what it sounds like. Regardless of the health or age of the policyholder, it never expires as long as the premiums are paid.
There are two main types of permanent life insurance:
- Whole life insurance pays a death benefit while also allowing cash value to accumulate
- Universal life insurance is a more flexible version of whole life insurance. It allows for adjustable premiums and lets policyholders borrow against the accumulated cash value of the policy.
Pros and Cons of Permanent Life Insurance
Some people prefer permanent life insurance for its predictability and guaranteed cash value. Knowing that your age and health status will never impact your premium cost is a significant benefit.
However, permanent life insurance is considerably more expensive than term life insurance, which means keeping up the premiums can become a significant burden for some people.
Additionally, the savings or investment vehicle may not be efficient. There might be better uses of the premium money.
No one enjoys contemplating their own mortality, but failing to do so can leave your family in difficult circumstances in the event of your death.
Putting a strong financial plan that includes adequate life insurance in place is one of the easiest ways you can keep taking care of those you love, even after you’re gone.