What Type Of Life Insurance Do I Need?
While our own mortality is not something that we like to think about, the unfortunate truth is that not everyone lives to be 100 years old.
Whether you are 20, or 70, life insurance can play an important role in providing your loved ones, your business, or your estate, with much needed cash and liquidity in a time of need.
But what type of insurance is most appropriate?
That answer depends very much on the need to be addressed, and the ultimate goals you have.
The most basic starting point is to determine whether you need temporary insurance, permanent insurance, or both.
Temporary Versus Permanent
Despite the fact that the life insurance industry has had quite a bad rap over the past 10-20 years, due primarily to unethical and aggressive sales tactics, the industry as a whole has done a tremendous job of creating new products catered to individual needs.
Temporary (referred to as term insurance) versus permanent insurance is a great example of this.
As their names imply, term insurance is designed to insure a temporary need, and permanent insurance is meant to address a permanent need.
Let’s look at a quick example:
- Bob is 32 years old, has owned a home for 7 years (with 23 years left on the mortgage) and has two children, ages 4 and 7. Bob’s wife, Sandy, works a full-time job staying home with their children. Bob does very well for himself, and makes a little over $200,000 per year. From the plan he and his financial planner have created, he anticipates having somewhere between $4 million and $5 million when he retires.
What are Bob and Sandy’s temporary needs?
Bob currently has two primary temporary needs: His mortgage, and his children.
Why are these needs temporary? Well, his children will (theoretically) be out of the home and through college in 18 years (when his youngest is 22 years old). And his mortgage will be paid off in 22 years.
Given that Sandy does not work, it is important that they consider what would happen should Bob not be around to provide for them.
Term life insurance provides a tool with which Bob and Sandy will be able to have the financial ability to pay off their mortgage, AND send their children to college, even if Bob passes away at an early age.
To accomplish this, Bob should purchase a 25 year term policy (most carriers only offer policies in increments of 5 years). The face value (how much the policy will pay its beneficiaries) should be large enough to cover the costs to pay off the mortgage, and send his children to college.
Of course, this calculation is much more complicated, but at its most basic level, this is where an insurance planning discussion starts.
What are Bob and Sandy’s Permanent Needs?
In addition to the temporary needs listed above, Bob and Sandy also have the following permanent needs: Retirement and estate planning.
Most people don’t think of insurance as a retirement planning tool, but several types of life insurance, specifically whole life insurance, provide many benefits.
Whole life insurance, like all life insurance, provides a death benefit to a policy holders beneficiaries upon the death of the insured.
However, whole life policies also tend to accumulate a cash-value much more quickly than other insurance products (typically requiring a larger premium to accomplish this). The cash-value of the insurance policy grows tax-free, and is usually not taxable when withdrawn from the policy.
These cash withdrawals can be an important source of retirement funds for a family, and have the potential to be quite substantial due to the tax-free growth of the proceeds within the policy.
In the event no withdrawals are made from the policy, whole life insurance still pays out a death benefits to its beneficiaries.
If all goes according to plan, it is very likely that Bob and Sandy will leave a sizable estate to their heirs. Unfortunately, this also means the potential for a sizable estate tax burden.
Depending upon the size of the estate, taxes can take away over half of a family’s estate, leaving beneficiaries with much less than intended, and Uncle Sam with much more.
Life insurance can provide two benefits in this situation.
One, premiums paid into the policy, while an expense, also reduce the size of the policy owner’s estate, thereby reducing his/her estate tax liability.
And two, the proceeds from the insurance policy are usually paid out tax-free to the beneficiaries, which, when set up properly, can be used to pay for some, or all, estate taxes incurred when passing assets to the next generation.
As you can see, the type, and amount, of any life insurance you may need varies significantly based upon your ultimate intentions.
There is no right or wrong answer for what type of insurance you need, and no rule that says you can only buy one type. Many individuals own several life insurance policies, each meant to serve a specific need.
Just make sure that the insurance you purchase is the most appropriate, and most cost-efficient way to address the potential risks you face.