A part of every sound financial plan is being prepared for the “what ifs” in life. What if I want to send my kids to college? What if the markets tank? Or soar? What if I want to travel? Or retire early?
Or what if I die? Here is where life insurance becomes your front-line defense.
Understanding the basics of life insurance is critical to financial health. And a good place to start is with four questions.
1. Why do I need life insurance?
2. How much do I need?
3. What type?
4. For how long?
Why do I need it?
For most of us, life insurance is a way to replace income in case of an untimely death. There are many other sometimes rather sophisticated uses of life insurance, but for now, let’s stick to basics. It’s pretty straightforward. Everything you plan to do — pay your bills, your mortgage, save for retirement, for your children’s college, for that special trip, everything — is predicated on your ability to earn income. If you die, there is no more income. During your working years, life insurance simply allows you to shift the risk of loss of income to an insurance company.
How much do I need?
This question can stir up an emotional as well as economic bees’ nest, with sentiments ranging from, “I want my family to have everything in abundance,” to “I don’t want my husband/wife to get rich from my death.” Whatever your thoughts may be about providing for your surviving family, we recommend you start with having enough life insurance to cover basic expenses. This requires some number crunching on your part. You’ll want your family to be able to –
- Pay off the mortgage — It’s a good idea for your family to pay off your mortgage with your life insurance proceeds. Doing this will give them a place to live and eliminates a large monthly expense.
- Pay off other debt — After the mortgage, there may be other sizeable debts that should be cleared, like car loans, student loans, etc.
- Buy a house — If you don’t already own a house (no mortgage), your surviving family may want to use the proceeds to buy one.
- Fund college costs — College is expensive. Using life insurance proceeds to fund college expenses frees your surviving spouse from the worry about how they are going to pay for this big ticket item.
- Fund living expenses — Part of the proceeds should go toward current and future living expenses. How much do you spend each month? How much do you save each month? You can adjust the amount needed, depending on variables such as your spouse’s current or future income, how long he or she needs the income and so on.
- Fund final expenses — Losing a loved one is not cheap for the surviving family in many ways. Financially, they must bear the burden of high funeral costs.
At the least, life insurance allows a surviving family to “buy time.” It is a gift that affords them the time to mourn and deal with their loss as they create a “new normal.” This is especially important if there are children involved.
What type do I need?
When choosing a type of life insurance we generally recommend term insurance, if your primary purpose is to replace your lost income. This is because the insurance amount needed to cover lost income tends to be fairly large — as in one to many millions of dollars. Term insurance allows you to buy the most insurance for the lowest premium. Universal or whole life premiums can be prohibitively high for the same coverage.
How long do I need it?
If your insurance is meant to provide for surviving family members when a breadwinner passes prematurely — you want to have adequate coverage at least until all children become financially independent, typically after they leave home, graduate from college and land a permanent job. Once your kids have flown from the nest, generally it’s just you and your spouse remaining. If your spouse is working or otherwise can support themselves after your demise, you probably don’t need life insurance. Moreover, by then you may have accumulated enough assets to be self-insured.
However, the opposite may be true. There are many reasons why you or your spouse may be financially vulnerable. Maybe you lost money in a failed business, or raided your 401(k) to send your children to college and graduate school. It’s also not uncommon for some to lack marketable skills, having stayed out of the labor force for years to raise children. Or you may suffer from a health problem that, while not life-threatening, prevents you from being gainfully employed. In these situations, you may want coverage beyond the milestone of your children attaining independent adulthood.
Advisory services are offered by Joslin Capital Advisors, LLC, an SEC Registered Investment Advisor.