The previous article covered the basics of life insurance – the contract between the insurer and policy owner, factors that affect life insurance premiums, and uses for life insurance. This article will focus on examples of who needs life insurance. It will also look at determining the length of the policy as well as an amount of coverage.
Depending on your circumstances, life insurance may play different roles at different stages of your life. Here are a few examples:
- Young and married with no children – depending on your lifestyle, it may be hard to maintain the same standard of living if your spouse were to pass away. A modest amount of coverage to pay off any debt and replace missed income should suffice. Shorter term life policies with lower death benefits are typically the most affordable option.
- Young and married with children – young families need the most death benefit from a life policy because the need for income replacement that can cover the expenses for growing children is greater. Even if the spouse who might stay at home with the children were to pass away, it would be an additional expense for the surviving spouse to pay for childcare services and still work. Coverage to pay for potential college expenses as well as any household debt usually calls for larger policies. 20-30 year term policies are usually most suitable for young families.
- Single-Parent – like couples with children, single-parents who have young children usually need a policy with a larger death benefit. If balancing work and childcare has led to a lower income, then there may not be enough savings to care for the children if the parent dies. A term policy with a sizeable benefit can help to relieve this financial burden.
- Recent empty-nester – just because the kids are out of the house does not mean your life insurance needs end. You may need to help your children through college and maybe even after college. If your household runs on two incomes and you still have major debts like a mortgage to pay off, life insurance (either term or permanent policies) might still make sense
- Retired – hopefully at this point in your life, you have saved enough to get you through retirement and provide for your spouse if you die. While many people terminate life insurance policies at this point, there still may be a use for them. One of the most common forms of life insurance for retired individuals is final expense insurance. This type of coverage is meant to cover your burial and funeral expenses. It is also possible that permanent life insurance policies may help to provide estate planning benefits as well. The amount of coverage needed will vary based upon your specific situation and needs.
There is no exact science determining the specific amount of life insurance needed for each situation. However, there are three commonly used methods for determining an appropriate amount of life insurance:
- Multiple of income approach – by far the easiest to calculate, this approach usually recommends anywhere from five to ten times your current income. This approach is simple and easy to explain, but it does not consider current assets or liabilities.
- Financial needs analysis approach – identifies immediate cash needs and ongoing income needs and assumes life insurance policy proceeds will be liquidated to meet those needs.
- Capital needs analysis approach – similar to the financial needs analysis approach but it relies on meeting income needs with the earnings on the principal sum, without liquidating that sum.
Life insurance can provide confidence for young families or prove to be a valuable asset for retirees. One thing is for certain, there is not a specific type or amount that applies to everyone. Each situation is unique. The next two articles will focus on the different types of life insurance and the pros and cons of each.
Please let us know if you would like to learn more about the role that life insurance may play in your financial strategy. Please contact us and we would be happy to help.
