For many, the purchase of life insurance is a confusing and somewhat scary event. We all get a little squeamish when thinking about our own deaths and it is normal to want to avoid it. But life insurance is nothing more than a tool - and a very powerful one for your benefit. By learning how to properly use this tool, you will understand why it is a vital part of your financial toolkit.
Basically, insurance is taking a small amount of capital (the premium) and using it to buy a much larger sum to be available when it is needed (the benefits). In the case of life insurance, the premium purchases a lump sum of money that is paid out to your beneficiary in the event of your death – money buying money. In most instances, the money is received income-tax free which can then be used to provide future security for your family, liquidity for taxes or a business buy-out.
Because you are making long range financial decisions it is simply common sense to investigate life insurance with a qualified professional who can help you to make the most cost effective decisions. (This may also involve coordinating information from your accountant and attorney as well.) The following is some very basic information that I hope will be helpful as you consider if life insurance is appropriate for you.
There are three questions to consider when purchasing life insurance:
1. Do I need it?
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How much do I need to buy?
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What kind should I buy?
Do I need life insurance?
If someone is going to suffer financially from your death, then you need life insurance. Your spouse/partner or your children but it could also be your parents if you are caring for them as they age.
Many single people do not believe they need life insurance but like living, death is expensive – a policy for final expenses can cover funeral costs, debt, taxes, etc. A big one many singles miss: do you have student loans that were co-signed by your parents? You may be gone, but banks will continue to collect!
How much life insurance do I need to buy?
Depending upon your age, the general rule of thumb is 5-20 times your income. A financial needs analysis to determine your needs (expenses) vs. your resources is better. There are three types of expenses to consider. Immediate expenses are things like funeral costs, taxes, and debts. On-going expenses include mortgage/rent payments and day-to-day living expenses such as food and gas. Future expenses are those things out on the horizon – college and retirement.
Once you have a clear idea of your expenses, tally up all your resources - your partner’s income, savings and any current life insurance you may have. The difference between needs and resources is the amount of coverage needed.
What kind of life insurance should I buy?
The type of insurance depends upon how long you need the coverage and your budget.
Term Insurance
For many, term insurance is the most popular and suitable choice. Pure protection that is cheap, term lasts for a set period of time, thus the name ‘term’ – usually 10, 20, 30-years. Once the term ends, the premiums increase rapidly.
If you still need insurance at the end of a term, you will have to qualify for a new policy. It is a fact of life that as we get older, we begin to experience health problems which may limit our ability to qualify for a new policy. Most term policies have a conversion provision that gives you the option to purchase a permanent policy without having to go through underwriting but these are things to consider when you are initially choosing what kind of policy to buy.
Permanent Insurance
Permanent or cash value insurance is intended to last longer than term (“whole life" is called that because it lasts ‘your whole life’). In addition to whole life, there are also universal, variable and indexed policies, all which have an investment component. Permanent contracts are more expensive than term because not only can they last longer but unlike term, they can provide more than just a death benefit. Money can accumulate tax-free within the policy which can be accessed through loans, withdrawals or can be used to pay premiums down the road. Many policies now offer ‘living benefits’ such as long term care insurance, creating a hybrid contract. There is more complexity in permanent products and it is vital to review them periodically.
So which to buy? It depends on you and your situation. If your need is for a larger amount of coverage, but you are on a tight budget, term may be your best bet – the necessary hammer in your tool box. Permanent insurance though, has a lot of power. You may be concerned about long term care or maybe you have maxed out on your 401(k) and would like to fund a supplemental retirement vehicle - permanent insurance is your electric circular saw. Diversification is not just for stocks – a combination of term and permanent coverage can be a good idea if it is within your budget. Part of the power of life insurance is that as a tool it is very flexible; there is no one-size-fits-all option and plan design options are endless.
On-going Policy Review
Life insurance is not a once and done – marriage, kids, a bigger house is purchased, a job promotion, a divorce, second marriage –life moves pretty fast so make sure your insurance keeps up! A periodical review will tell you if you have enough of the proper coverage, can save some money or if your beneficiaries are still as you intended. (I see too many people that neglect to add on kids as beneficiaries once they are born and I have had to tell a client that her partner never changed the beneficiary on his life insurance policy so the proceeds went to the ex-spouse! Ouch!)
Just as you want your home to be well designed and built, you want your life insurance to be designed to meet your specific needs. You look for the best contractor possible to work on your house. It is just as important to look for a qualified professional when considering what life insurance is best for you.
This guest post was written by Marci Sheeran of MacCorkle Insurance Service in Burlingame, a local independent, full-service insurance brokerage. Marci is an Account Executive specializing in Individual Life, Disability and Long-Term Care Insurance. A 20-year veteran of the industry and a Peninsula native, she works with clients throughout the Bay Area.
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About MacCorkle Insurance Service
MacCorkle is a forward-thinking, highly experienced and full-service insurance brokerage firm. Driven by commitments to service excellence and leveraging technology to provide the most time and cost-effective coverage, the MacCorkle plans you choose will safeguard you, your business, your employees and your family, and ensure you are well-positioned for the future. MacCorkle's integrated insurance programs include Employee Benefits and Retirement Plans, Commercial Business Insurance, Individual and Executive Insurance, and Personal Insurance.
