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Life insurance can provide your loved ones with financial support after you die. It also offers potential cash value while you're alive. But do you need a policy?
It depends. But if you decide to purchase a policy, determine how much you need and understand the types of coverage available before enrolling.
When You Should Get Life Insurance
Having a life insurance policy is a smart move if you have a spouse, partner, relative or dependents who rely on your income for financial support. Otherwise, they could endure financial hardships if you pass away and your income is no longer available to cover household financial obligations.
If you're between 20 and 30 years old, single with no dependents and in good health, a policy may not be necessary. But if you don't have enough assets to cover your debt or want to leave money to others if you pass away, you may want to get life insurance.
How Much Life Insurance Do I Need?
Depending on your age, remaining working years and other factors, financial experts may recommend buying a policy that's anywhere from one-half to 30 times your annual earnings. So, if you're a 30-year-old earning $75,000 per year and plan to work 20 or 30 more years, a policy for $1.5 million or $2.25 million could be suitable. On the other hand, an older person may need less coverage if they're closer to retirement and their children are grown and supporting themselves.
You can use rule-of-thumb figures to gauge the amount of coverage you need, but it may or may not be enough to cover your family's current and future financial needs if you pass away. Instead, keep these factors in mind:
- Your liquid after-tax assets: Note the balances for your savings accounts, pensions, retirement accounts and estimated Social Security benefits. Also, jot down the value of current life insurance policies and any other liquid after-tax assets your family will inherit. Run the numbers to determine how much of your income your loved ones will have access to when you die.
- Your household expenses and debt obligations: Calculate the sum of all the expenses you cover with your income. If you cover all the household expenses, this would be the total amount of monthly bills, including your mortgage, utilities, child care, insurance, food and transportation costs, and any debt payments.
- Other expenses you would want to be covered if you passed away: When calculating the amount of coverage you need, be sure to include funeral and burial expenses. Also, add in college tuition and wedding expenses if you plan to cover these costs for your children.
Deduct your expenses and debt obligations from your liquid after-tax assets to gauge how much coverage you might need. To illustrate, if you have $65,000 in annual household expenses and debt, you'd need to provide $1.95 million over 30 years to cover costs. If you have $325,000 in liquid after-tax assets, you would need $1.63 million in life insurance.
Types of Life Insurance Policies
After deciding how much life insurance you need, it's time to shop around for a policy. You will quickly notice that there are two primary types of life insurance:
- Permanent life insurance: Permanent coverage insures you until the day you die (or up to the age of 99) if you remain current on your premium payments. Permanent life insurance also accumulates cash value that in some cases can be used to increase the death benefit amount but typically reverts back to the insurance company after your death. You can withdraw or borrow against the cash value, but the death benefit will decrease by the amount you take out. If you draw the cash value down to zero, the insurance provider will require you to cancel (or surrender) the policy.
- Term life insurance: This is a more affordable form of life insurance that's generally available for one to 30 years. Policies do not accumulate cash value, and your beneficiaries will receive the coverage amount if you pass away while the policy is active. If you outlive the policy term, you will need to purchase new coverage or renew the existing policy.
To determine which type of life insurance is best for your situation, assess the costs of each type of policy and how long you want to be covered. If you want cheaper coverage that lasts one to 30 years, a term policy could be right for you. But if you don't mind paying higher premiums or want to build up and tap into the policy's cash value, permanent life insurance is likely a better fit.
Assess Your Needs Before Buying Life Insurance
Life insurance can protect your loved ones from financial hardship if you pass away. Plus, you'll have peace of mind knowing the assets left behind are secure.
Shop around to find policies that meet your coverage needs and work for your budget. A broker can help you explore several products without you having to do much legwork. You can also contact your insurance provider to determine if they also offer life insurance.
Be mindful that the best premiums are reserved for young adults in good health. So, consider buying a policy sooner than later if you have a spouse, partner, relative or dependents who rely on your income to cover household expenses. If you're single, a life insurance policy is also a smart move if you have more debt than assets or want to leave money behind for loved ones.