Life insurance is designed to protect a policyholder’s beneficiaries in the event of an insured person’s death. The death benefit can help compensate a family for the deceased person’s lifetime income or provide cash to pay any debts or business expenses they left behind. But even though the basics of life insurance are easy to understand, it can be difficult to know if or when you need a policy of your own, and how much life insurance you might need. Here’s what you need to know about life insurance so you can decide for yourself.
How Life Insurance Works
Life insurance policies have three main characters:
- An owner or policyholder.
- The person whose life is insured (often the policyholder, but doesn’t have to be).
- The beneficiaries who receive the death benefit (can be one or more).
Term life insurance is in effect for a specific term, generally between one and 30 years, and will only pay out the death benefit if the policyholder passes away during that term. If you outlive the term, your beneficiaries will receive no benefit from this kind of policy. Term life insurance tends to be the least expensive type of life insurance.
Permanent life insurance covers you for your entire life. The insurer charges more in premiums compared with term life insurance, but premiums can remain level, even though your risk of death increases over time. This is because a portion of the “additional” money you’ve paid to the insurer (relative to premiums you’d pay for a comparable term policy) builds up as a cash value, which you can access during the life of the policy. That means this kind of life insurance can be used as a type of savings vehicle, giving the policyholder a potential source of late-in-life income.
Why Buy Life Insurance?
In general, there are several common reasons for purchasing a life insurance policy, including:
- To replace the policyholder’s income for any dependents who rely on that income.
- To pay for funeral expenses and other final expenses.
- To provide a financial legacy for heirs.
- To pay estate or inheritance taxes.
- To provide a donation to a favorite charity.
- To create a savings vehicle if there is or may be a life insurance need.
- Who Needs Life Insurance?
You Own a Business
Business owners may need life insurance to guarantee the survival of their business after their death, to provide heirs with the cash necessary to dismantle or sell the business, or to insure another employee key to the success of the business. Additionally, anyone who co-owns a business with another person may need a policy that will allow each partner to buy out the other’s half of the business after their death.
You Carry a Great Deal of Debt
Most debts owed solely in your name must be paid off by your estate after you die, and co-signed loans become the co-signer’s responsibility if you pass away before paying them off. Dying while carrying debts could mean your estate goes entirely toward paying off your creditors—potentially leaving any loan co-signers on the hook for debts you agreed to pay. A life insurance policy can help pay off your debts so they don’t affect your heirs.
Federal and some private student loans are discharged upon death of the borrower (or the student who took them out).
You Want to Cover Your Burial Expenses
The median cost of a funeral with a viewing and burial was $7,640 in 2019, according to the National Funeral Directors Association. Carrying a life insurance policy that will cover the cost of your burial can help you feel confident that your death will not be an added financial burden to your family, especially if you have any concerns about their ability to afford a funeral. In addition, final expense insurance (a specific type of life insurance geared toward paying for burial expenses) tends to be very affordable, since the death benefit is typically low, often in the $10,000 range.
How Much Life Insurance Do You Need?
The amount of life insurance you need depends on why you need the insurance.
Enough to Support Your Family
People with dependents are often advised to purchase a life insurance policy equal to a multiple of their salary. This rule of thumb is a quick way to determine a death benefit that will provide several years of replacement income. However, it’s smart to use this rough calculation as a starting point, and then actually crunch the numbers on how much your dependents will need.
Consider how much other income they will be able to count on and how much non-salary income from your employer (such as health insurance subsidies or retirement contribution matches) will be lost when you die.
What Your Heirs Need for Your Business
If you’re purchasing insurance to protect your business, you should determine how much money your heirs will need to take over or sell it, how much you’ll need to replace a key person upon their death, or how much any co-owners will need to buy out your share.
Enough to Clear Your Debts
Life insurance shoppers who are concerned about leaving debts behind can calculate their death benefit based on the amount it will take to clear their debts after death. And those who wish to leave money to pay for their burial and other final expenses can fill out a funeral pricing checklist to estimate their insurance needs.
In some cases, though, the amount of coverage you require will be greater than what you can afford. You may wish to address this by purchasing a combination of term and permanent insurance, only term insurance, or a term policy that you can convert to a permanent policy later.
Less Common Life Insurance Needs
In addition to the typical reasons for carrying life insurance, a policy can help cover several less common needs, including: Insuring Children Buying a policy on a child can ensure the family will financially survive the loss of the child, though such a loss is relatively unlikely. It can also ensure the child’s ability to qualify for life insurance later in life, even after a health diagnosis that might otherwise make it impossible to pass life insurance underwriting.
Replacing Retirement BenefitsThough life insurance is typically marketed as income replacement for an insured during their working years, some retirees may choose to keep a life insurance policy after leaving work to replace the loss of any retirement income for the benefit of their spouse or any dependents.
InvestmentCarrying permanent life insurance can provide the policyholder with a potential income source. Not only can you access your cash value once it has built up to a certain level, but some policies also allow for an accelerated death benefit, which lets a policyholder access the death benefit while they’re still alive in case of a triggering event, such as being diagnosed with a terminal illness, requiring extreme medical intervention, or needing nursing home care.
Is Life Insurance Worth It?
The decision to buy life insurance is personal, since so many of the insurance calculations depend on your circumstances, financial situation, and future plans. But even individuals who don’t currently have dependents, a business, or significant debt may want to look into getting life insurance. That’s because the cost will go up as you age, meaning right now is likely the cheapest time for you to buy a policy. In addition, even the best planners can’t predict the financial fallout of your demise, so carrying some life insurance can provide a layer of financial protection for your beneficiaries. Thinking through the potential financial issues that could arise after your death can help you answer the questions of if, when, and how much when it comes to buying life insurance.