Life insurance can be confusing and complicated, but it boils down to having a backup plan. It’s a way to protect your family and business and lessen the financial blow in case you die unexpectedly. If you have people who rely on your income to survive, you might want to consider life insurance.
Do I need life insurance?
If you have loved ones relying on your income who would suffer a financial loss if you died unexpectedly, you might want to consider life insurance.
Life insurance plays a key role in financial planning. It protects your family and gives them a sense of financial security for the future. It offers liquid cash to cover expenses, including your funeral costs, outstanding debt — like a credit card or student loan, mortgage payments and college costs. For a grieving family, life insurance alleviates some of the stress that comes with managing money when a key earner or breadwinner is no longer around.
When you die, your life insurance policy kicks in to provide the money your beneficiaries need to maintain their lifestyles. Along with replacing your income, the death benefit can also be used to pay estate taxes, donate to charity and leave an inheritance to your children or grandchildren. Speaking of legacies, if you’re in a second marriage, it can help to balance things out and serve as an asset to pass on to your kids and spouse.
If you’re a business owner or partner, think of a life insurance policy as a backup plan: It can cover your most valuable employees and provide much-needed cash flow for the company while it recovers.
Reasons to buy life insurance
If these situations apply to you, consider purchasing coverage:
- You have debt. Unfortunately, your debt doesn’t die with you. If you have outstanding debt on a student loan, car loan, credit card or mortgage, you might want to take out a policy to cover those balances. This will ensure those repayments don’t fall to your cosigners or loved ones when you die.
- You’re married. Does your spouse rely on your income? If so, consider purchasing coverage and naming your spouse as a beneficiary. That way, if you die prematurely, your policy would kick in to help them to pay off debts, pay the mortgage or rent, cover your funeral costs or maintain their lifestyle.
- You have young children. As a parent, you’ll probably support your children financially until they enter the workforce and start earning their own money. Many young parents purchase a policy that carries their kids through college. If they die before then, their policies can pay for things like childcare, education and housing. You can also set up a life insurance trust and decide how and when the money will be distributed to your kids.
- You own a business. A life insurance policy can provide your company with much-needed cash flow and a sense of financial security if you die early. Your family could also use the proceeds from the policy to pay off any business loans that were secured with personal assets, like your home.
If you’re a partner in a business, life insurance can fund a buy-sell agreement, too. If one partner dies, the other one can use the death benefit to buy out the rest of the business.
- You have a large estate. If your estate is worth $11.4 million – the IRS threshold for 2019 – or more, your estate will be subject to federal estate taxes.
To protect your family’s wealth, you could use a permanent life insurance policy as an estate planning tool. When you die, your heirs could use that money to pay the estate taxes – which are due nine months after your death.
How to buy life insurance
You can either use an agent or broker, or you can purchase a policy directly from the insurer. Either way, it pays to do your research, collect quotes and compare providers and policies to make sure you’re getting the most value for your money.
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How much coverage should I get?
When you’re working out how much coverage to carry, consider three things: your income, your assets and your financial obligations.
The general rule of thumb is to buy a policy that would replace your income and cover your family’s cost of living for five to 10 years. To crunch the numbers, choose a target number — like 10 years — and work backward. Use your salary as a starting point, and think about any other funds your family would have access to when you die, like 401(k)s, savings accounts and Social Security. If you think your family would need $500,000 to pay for their living expenses over 10 years, a $500,000 policy may suit you.
A simpler way to do this is to stick to your salary. If you’re earning $50,000 a year, you might be a good candidate for a $500,000 policy.
As you climb the career ladder, you’ll most likely build your wealth and acquire assets, such as a house, car, savings account or a healthy 401(k). These assets make up your estate. When you’re calculating how much life insurance to buy, add up your assets. This gives you an idea of how much coverage you need to add to your policy, on top of your income.
Let’s say your estate is worth $250,000. A $250,000 policy can protect that and provide liquid cash to pay estate taxes.
That being said, if you’re a careful saver with healthy bank accounts and lucrative investments to your name, you may not need as much life insurance.
Your financial obligations
To find this dollar figure, think about everything you pay for now and everything you expect to pay for in the future. Your responsibilities may include:
- Debt. Unfortunately, your debt doesn’t die with you, so you’ll want to leave enough money to cover your mortgage, student loans, car loan and credit card debt.
- Children. The younger they are, the more coverage you’ll want to get, especially if you’re paying for childcare. Most people go for a policy that covers their children until their 20s, when they’re working and earning money themselves.
- Spouse. If your partner is a stay-at-home parent or low-income worker, add more coverage. If they are the breadwinner or much younger than you, you may be able to reduce it.
- Care for aging parents. If you’re covering medical expenses for a parent or paying for a nursing home, consider those costs as part of your life insurance policy.
- College costs. If your kids are planning to go to college, take those costs into account. Increase your coverage for each child, and look at the kinds of schools they’re hoping to apply to.
- Business expenses. Do you own a business? A life insurance policy can give the company and its employees financial security in case something happens to you. The value of your business determines how much coverage you need.
- Legacy. Once you account for your financial responsibilities, you might want to look further ahead and add cushion coverage to your policy to leave behind a legacy for your children and grandchildren.
Remember, you should only buy as much life insurance as you need. If you end up earning more money, acquiring more assets or picking up more financial responsibilities, you can purchase another policy to cover those needs. This is known as laddering.
What should I expect when I apply for life insurance?
The application process is pretty straightforward, but can take between three and eight weeks. With most providers, you can expect to go through these steps:
- Fill out an application form. You’ll be asked to provide basic information about yourself and to answer questions about your health and lifestyle. The form will also ask you to detail your family medical history, including any serious medical conditions like cancer, diabetes and heart disease.
- Undergo a medical exam. Unless you’re applying for guaranteed or simplified issue life insurance, you’ll likely have to take a medical exam. A medical practitioner will come to your home or office and record your height, weight and blood pressure. They may also request a blood or urine sample.
- Play the waiting game. The insurance company assesses your application. The underwriters look at your age, health, lifestyle, occupation and medical history. They may check your DMV, pharmacy and Medical Information Bureau (MIB) records, too.
- Review the result. The insurer will either accept or reject your application. If they don’t accept it, they may offer you an amended version of the policy. They might increase the premium to cover an unexpected risk, reduce the level of coverage or exclude a specific medical condition.
- Finalize the policy. Once both parties have signed off on the conditions, the insurance company issues your policy.
At its core, life insurance is simple: Pay now to protect your family and business later. If you have financial dependents, you might want to consider life insurance. When you die, your policy would provide them with cash to cover their living expenses and would ensure they’re not saddled with a financial mess.
To learn more, check out our guide to life insurance.
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