Life insurance often receives a bad rap from consumers. Frankly, the way it's sometimes sold I can understand why.

Nonetheless, life insurance is an important financial planning tool and financial advisors can play an important in helping clients determine their life insurance needs. (For more, see: How to Fund Retirement with Insurance.)

Why Life Insurance?

The first step is to look at the client’s situation to determine why they would need life insurance. Here are a few examples where life insurance can provide an excellent solution:

  • Life insurance can give a non-working spouse time for important decisions with less financial pressure. A death benefit probably won't last a lifetime, but it gives the beneficiary time to decide whether to work, keep or sell a home, start career training and more. This is especially vital for a breadwinner with a young family.
  • Life insurance is a cheap way to build an estate. It can be used by younger families that have not had time to accumulate assets or mid-career breadwinners who haven't been able to save as much. A life insurance policy can be used to fund retirement, pay for college tuition or give survivors a soft landing.
  • Life insurance can help business continuity in the event of the death of an owner. Life insurance is frequently used for buy-sell arrangements, under which the proceeds of a policy are used to buy out the deceased owner's interest and compensate their heirs. Such an arrangement helps remaining owners avoid working with a surviving spouse or family member who may not have had any involvement in the business.

These are just a few situations where life insurance might provide a viable solution. The key here is to determine the reason that the client needs a life insurance death benefit. (For more, see: Financial Advisor Client Guide: Life Insurance and Is Life Insurance a Smart Investment?)

Ask Questions

It is important to look at the client’s situation to determine why they would need life insurance as part of any financial planning engagement or financial advisory relationship. Here are a few questions to ask:

  • Is the client married, do they have children? Would the surviving spouse be able to support themselves and their children either via their current employment or by rejoining the workforce?
  • Are the children minors or young enough where the death benefit would be needed to insure their future needs (maintaining the family’s lifestyle, college, etc.)?
  • Would the client’s death trigger additional expenses such as daycare?
  • Is the client older and near retirement? Is so do they have sufficient assets to support a surviving spouse and others in the event of their death? With the client gone does the surviving spouse have enough assets for a comfortable retirement?
  • Are there estate planning considerations that might call for life insurance?
  • Does the client have charitable inclinations after their death that could be funded via life insurance?

Look at the Death Benefit First

The first consideration is to determine the death benefit that is needed.

Insurance is often sold as a solution to a myriad of other financial problems such as saving and investing for retirement. Generally in my experience life insurance policies that have a cash value investment component are often relatively expensive if used for this purpose. (For more, see: CPF Study Guide: Taxation and Business Uses of Insurance - Policy Withdrawals and Death Benefits.)

While some reps may tout the fact that tax-free policy loans can be an option for retirement, I’ve usually found that high-earning professionals should consider more standard retirement plan vehicles such as a 401(k) and a pension plan first. Generally the underlying investments in a life insurance policy are expensive and often investors can do better investing outside of the policy. (For more, see: How Cash Value Builds in a Life Insurance Policy.)

There are advanced planning situations where various forms of permanent life insurance do make sense, but for most people it makes sense to focus on the most cost effective way to get the death benefit needed for their situation. (For more, see: Tips on How Financial Advisors Can Talk to Clients.)

How Long is the Death Benefit Needed?

Another consideration is the length of time the death benefit might needed. For example a person who is in their early 30s, has two young children and a non-working spouse will likely need the death benefit for 20 years or more at least until the children are through college. (For more, see: Buying Life Insurance: Term Versus Permanent.)

While many might think the need for life insurance goes away once the kids are out of the house this may or may not be true. If you haven’t saved enough for retirement the death benefit might provide added security for a surviving spouse if you die early in it might replace retirement savings that you were not around to contribute. (For related reading, see: Shifting Life Insurance Ownership.)

Future Insurability

We never know what life will throw at us in terms of health so purchasing term life insurance with the option to convert to some form of permanent life down the road is not bad idea if the client thinks they might have a need for insurance after the end of any period of level premiums. (For more, see: Permanent Life Policies: Whole vs. Universal and Cut Your Tax Bill with Permanent Life Insurance.)

The Bottom Line

Life insurance is a key financial planning tool and financial advisors can help their clients determine what their like insurance needs are and the best type of policies to fill those needs. Life insurance needs will likely change over the client’s lifetime and again financial advisors can provide an objective sounding board, without any sales pressure, for their clients. (For more, see: Life Insurance: Putting a Price on Peace of Mind.)

Want to learn how to invest?

Get a free 10 week email series that will teach you how to start investing.

Delivered twice a week, straight to your inbox.