Even for those who feel like they’re at the peak of life, the future is never certain, so thinking through the financial implications of a sudden illness or accident can be a wise move. Does that mean you need life insurance? If there are people in your life who depend on your earnings, and you don’t have an enormous bank account to leave behind, the answer is likely “yes.” For parents, entrepreneurs—even young people with outstanding student loans—the promise of a death benefit can provide peace of mind that your family or business associates will be protected.
- Life insurance is an important source of protection for parents and other consumers who have financial dependents.
- You can choose between term insurance—which covers you for a certain number of years—and permanent policies that will protect you throughout your lifetime.
- To figure out how much coverage you need, it’s important to estimate your loved ones’ expenses and how much income they may be able to generate from work or other sources.
- Riders can be used to enhance and expand your life insurance policy's benefits to cover long-term care needs or provide an accelerated death benefit.
Why Buy Life Insurance?
Life insurance can serve an important purpose within a comprehensive financial plan. A life insurance contract allows you to choose one or more beneficiaries to receive a death benefit when you pass away. The amount of this death benefit can range from as little as $10,000 to more than $1 million, depending on your needs.
The proceeds from a life insurance policy can be used in a number of ways, including:
- Covering funeral and burial expenses
- Paying off any outstanding debts owed by your estate
- Creating a supplemental source of income for your loved ones
- Helping with college expenses for children or grandchildren
- Providing a nest egg of savings for a spouse's financial needs
Life insurance policies can be even more valuable through the addition of riders. Riders can be used to expand your policy's coverage. For example, you may choose a rider that covers long-term care if nursing home care becomes necessary. Other riders can offer accelerated death benefit payments to cover end of life care or guaranteed insurability, which would allow you to increase your death benefit amount periodically.
Adding one or more riders to an existing life insurance policy can increase the amount you'll pay for premiums.
What Types of Life Insurance Can You Buy?
Life insurance policies generally fall into one of two categories: term life or permanent life.
Term life insurance covers you for a set term, i.e. 10 years, 20 years, 30 years, etc. The main appeal of this type of life insurance is that it tends to be the least expensive option with regard to premiums. Generally, the younger and healthier you are when you purchase a policy, the cheaper premiums tend to be.
Permanent life insurance covers you for your lifetime, as long as premiums are paid. Permanent life policies include whole life, universal life and variable life insurance. Some permanent life policies feature an investment component that allows you to build cash value.
Whether you purchase term life insurance or a permanent policy, you may need to complete a medical exam as part of the underwriting process to determine your risk class.
Who Really Needs Life Insurance?
The key question when it comes to buying life insurance is whether there are people in your life, including family members and employees, who depend on you financially. Below are some of the types of people to whom a policy may bring added peace of mind.
Parents With Young Children or Special Needs Dependents
For many adults, the arrival of a baby is the time they start thinking about life insurance for the first time—and with good reason. Unless your family can get by comfortably on your savings or your spouse’s or partner's income alone, you likely need a financial backstop.
You may need coverage that can help take care of general household expenses, such as the mortgage and food bills, as well as all the outlays that go along with raising kids, such as daycare, sports and recreation fees, and, of course, college.
If your children are a little older—say, high school age—you may only need a policy that lasts long enough for them to enter the workforce. For those who buy term insurance—the simplest and cheapest form of coverage—a five- or 10-year policy may be all you need.
A life insurance policy can also be used to provide financial security for special needs dependents. If you have an adult child who requires specialized care, for example, your policy's death benefit could ensure they continue to receive that care without financial conflicts after you're gone.
Spouses Who Provide Most of the Income
Adults with young children in the house aren’t the only ones who might need life insurance. It can also provide a safety net for spouses who depend on your income. Consider whether your partner would be able to handle the mountain of expenses most couples incur every month, from home and auto loans to grocery and utility bills.
Spouses who have been out of the workforce for a long time or lack the skills to earn a strong paycheck are particularly vulnerable from a financial perspective. You should consider a policy with a large enough death benefit that they’ll be able to maintain their living standards even if you should pass on before them.
While it’s true that many employers offer life insurance, it may not be enough to meet your family’s needs. Often those group policies only offer a death benefit equal to one year’s salary, although they can be more or less than that amount. It’s also important to keep in mind that you often can’t take these policies with you should you leave the job for any reason.
Older Adults Without Savings
Retirement-age adults without a large amount of savings to draw on may want a life insurance policy just large enough to pay for funeral or cremation expenses when they die. According to the National Funeral Directors Association, the average cost of a funeral with burial was $7,640 in 2019, while the average cremation and funeral service cost $5,150.
A number of insurers offer “final expense” policies, which are typically whole life policies (they include a cash value component) that don’t require medical underwriting. Because these policies tend to be smaller—just enough to cover your funeral —they’re often far more affordable than other whole life policies for older adults.
Final expense life insurance pays out just enough to cover your funeral expenses, making it surprisingly affordable for older adults.
Adults With Private Student Loans
In general, younger adults without children can often get by without life insurance coverage. One possible exemption, however, are those carrying private student loans with a cosigner.
While parents typically aren’t required to pay back federal student loans if the borrower passes away, that isn’t always the case with private loans. Ask your lender what its rules are regarding the death of a borrower. In some cases, should the primary borrower die, some private lenders will go after anyone who cosigned on the loan.
If leaving your family in the lurch is a worry, you may want a term policy that covers the duration of your loan repayment. Should you end up paying down the loan ahead of schedule, you can simply let the policy lapse.
If you own a small business, you need to think about what would happen to your organization and employees should something happen to you. Often entrepreneurs will take out a special policy called “key person insurance” that can help keep the business afloat if you or another critical member of your team dies.
Essentially, it’s a life insurance policy in which the company pays the premiums on the policy and acts as the beneficiary. Should something happen to the company’s owner, the remaining employees can use the money to pay creditors, search for a new top executive, or even manage severance payments if staying in business isn’t possible.
Life insurance can also be used as part of a buy and sell agreement among business associates. The partners take out a policy on each co-owner and use the proceeds to purchase the deceased owner’s share of the business.
One rule of thumb for new parents is to take out enough insurance to cover 10 times their annual salary, but this doesn’t suffice in every case.
How Much Insurance Do You Need?
No two families have the same financial needs, so when determining the size of your life insurance policy, you really have to look at your own situation. To start, you’ll want to figure out all the expenses your beneficiary (often a spouse) would incur in the years after your passing. If you’re married, you also have to factor in what your spouse will realistically earn, both in short- and long-term horizons. The death benefit from a life insurance policy can help smooth over any shortfalls.
According to a report by LMRA, as reported by CNBC, a common rule of thumb suggests that newer parents take out enough insurance to cover 10 times their annual salary. While that may be fairly accurate in a lot of cases, it will land way off target in other situations.
Those who have a high-earning spouse or hefty personal savings, for example, may get by just fine with a smaller financial cushion. Conversely, parents with multiple young children and a stay-at-home partner will have to bridge a much larger budget gap. Putting a pencil to paper and estimating all major expense categories—for every year until your child hits the workforce full time—will help you make a more educated decision.
For those with more-specific financial goals, such as protecting cosigners on your student loans or preparing for funeral expenses, you’re likely going to want a much smaller policy. In the case of education loans, you’ll likely want a term policy that’s just long enough to cover the duration of your payback period.
The Bottom Line
Life insurance can be a great way to ease your mind by protecting your dependents in a worst-case situation. If you’re a parent of young kids or have a spouse with limited earning potential, signing up can be one of the best financial decisions you make. Still, for those who don’t have dependents and simply want to build long-term wealth, look at cheaper, less restrictive options first. Taking time to research the best life insurance companies and your various options for coverage can help you find the policy that's right for you.