Life insurance is an important but often misunderstood part of the financial planning process. Knowing who needs life insurance, how it works and the different types of insurance can help consumers make informed decisions about this product.
Who Needs Life Insurance?
People who have a spouse or children who depend on them financially need a life insurance policy. In addition, anyone who has an ex-spouse, life partner, financially dependent parents or financially dependent siblings should also purchase life insurance. People who are financially independent and have no spouse or children are unlikely to need life insurance.
Why Life Insurance Hedges Risk
Life insurance should not be viewed as an investment, but rather as a risk management tool and a hedge against the financial consequences of loss of life. Therefore, when purchasing a policy, consider the costs loved ones would face if you died. For example, an individual with large outstanding debt, such as mortgages and student loans, or a large family, probably requires a larger policy than an individual with a smaller family and few financial obligations.
Who Needs Term Insurance?
Most life insurance falls into one of two categories: term life insurance and permanent life insurance. Term life is the most affordable and widely available life insurance. Term policies, which are often provided by an employer, give coverage to an individual for a set term or period of time. A typical term might be 10, 20 or 30 years. A term policy pays a benefit only if the insured dies during the term. Most term life insurance policies pay the same benefit throughout the term, although with some policies, the death benefit drops over the course of the policy's term.
Term insurance is a good option for younger individuals and families who need affordable protection for a stated period of time in case a primary income earner dies. At the end of the term, the individual might be more financially secure and less in need of coverage, so term insurance provides a way to manage risk for younger, more financially vulnerable individuals. If not offered through an employer, term insurance usually requires a medical exam. Another advantage of term insurance is its simplicity and transparency. The term insurance market is competitive, so consumers can shop and compare prices easily.
Who Needs Permanent Insurance?
Unlike term insurance, which only provides coverage for a specified term, permanent insurance generally provides protection for the insured's entire life. Permanent insurance accumulates a cash value, which the policyholder may borrow against tax-free. However, because permanent coverage is more comprehensive, its premiums are usually higher than premiums for term insurance.
Permanent insurance may be a good option for high-net-worth individuals (HNWIs) who need cash to pay projected federal estate taxes. Individuals who have high levels of debt may also benefit from a permanent policy. Since some state laws protect cash value and death benefits of insurance policies from claims by creditors, permanent policy holders can use the benefits from a permanent policy without risk of a judgment or a lien against the policy. Permanent life insurance also forces individuals to save money. In fact, some policies pay attractive tax-deferred interest rates to policyholders. Retirees, for example, can use a survivorship-permanent policy to guarantee that their children receive an inheritance while they have the funds to retire. However, most retirees do not need life insurance when they retire unless they still have dependents or must pay for funeral expenses.
The Bottom Line
Knowing and understanding the different types of life insurance should help consumers narrow their choices. For starters, individuals should check with their employers to see what coverage they already receive. In many cases, this insurance is inadequate for individuals with large families and considerable financial obligations. However, individuals with employer-sponsored policies can supplement their policies with employer-sponsored supplemental insurance or coverage through private companies. Ultimately, the right coverage may consist of a combination of several policies. Individuals should speak with a licensed agent to assess their needs.