Life insurance is a key component of your family’s estate plan, offering those who depend on you for their financial security a safety net in the event of your death. Whether those dependents include your spouse, children, aging parents, business associates, or all of the above, investing in life insurance is a way to say “I love you” and make sure that when you pass away, the people you love will have a reliable source of financial support to count on.
Although purchasing life insurance may seem pretty straightforward, it can be rather complex, especially given the different types of coverage available. Plus, because insurance agents often earn hefty commissions on the policies they sell, it can be challenging to determine precisely how much coverage (and what type of insurance) you need – and who you can trust to give you objective and accurate advice about that coverage.
With this in mind, we’ll break down the common types of life insurance coverage, explain how each of the different kinds works, and outline what you need to know to purchase a policy that will adequately address your needs, objectives, and family situation. While you should always meet with your Personal Family Lawyer® to ensure you get the proper coverage, here are a few of the most important factors to consider when shopping for a life insurance policy.
Betting On Your Life
Depending on the type and purpose of your coverage, a life insurance policy pays benefits to your family or business (whomever you choose as the beneficiary) in the event of your death. And while you don’t need it until you die, the earlier in life you purchase your policy, the less expensive your monthly or annual premiums will be. Of course, investing in life insurance early on also means that you’ll pay into the policy for a more extended period.
The healthier you are when you get life insurance, the less you’ll pay in premiums because your policy is a bet between you and the insurance company about when you’ll die. The insurance carrier is betting they’ll be able to earn enough from the premiums you pay before you die so that they’ll have received more than enough money to pay out the death benefit to your designated beneficiaries by the time you pass away. To that end, many carriers require a medical exam before you are issued a policy.
Life insurance comes in two primary forms, which you can think of as permanent and non-permanent. With permanent coverage, such as whole life and universal life, as long as you pay the premiums, your insurance cannot be canceled, and your policy will be there and payout when you die (unless you live longer than the guaranteed period).
With non-permanent coverage, known as term life insurance, you pay premiums over a certain number of years – usually 10, 20, or 30 – and if you have not died during that period, the insurance ends, your premiums are gone, and no benefits are paid out when you die.
Permanent vs. Term Life Insurance: Which Do You Need?
To determine which type of life insurance policy you should purchase for your family – permanent or term – you’ll need to consider several factors. When it comes to buying life insurance for your family, you will need to die with life insurance coverage in place if any of the following three scenarios apply:
- You are likely to have dependents – minor children, a non-working spouse, or senior parents – who rely on you for their financial needs, and you will not have enough saved up at the time of your death to provide for their needs for the rest of their life.
- You have a business that will need a cash infusion if you die to keep it running, until it can be sold or for your loved ones to buy out a business partner.
- You will have an estate tax bill that you want to make sure is covered by life insurance so your family doesn’t have to sell assets to pay your estate taxes.
In each of these situations, you want to make sure you have either term life insurance that will continue long enough to cover your needs, or you’ll want to consider purchasing permanent coverage.
Term Life Insurance
The coverage periods of term life policies can vary widely: 10, 15, 25, 30 years, or longer. Because your coverage expires after a certain number of years, term life insurance is cheaper than permanent. Term policies are typically used by people who expect to only need the insurance for a certain period or a particular purpose. Still, they will no longer need the coverage at some point in the future.
For example, you might purchase term life coverage to pay off your home mortgage in the event you die before it’s paid off. Or you might have minor children, who rely on your income for their basic needs, and you need a term policy to ensure they have enough money to live on until they become financially independent should you die before they reach adulthood.
Permanent Life Insurance
Permanent life insurance comes in several forms, such as whole life, universal life, and variable universal life. And it’s mainly used for estate tax planning very high-end income tax planning. It can also be used as key-person insurance, which pays out benefits if you fill a vital role in a company that would need cash upon your death to continue operating. As mentioned earlier, the various forms of permanent life insurance pay a death benefit whenever you die, no matter how long you live (unless the policy contract has a termination provision at a specific age).
Permanent life insurance policies typically have two components: the amount that goes toward paying for the life insurance, and the amount that builds up as an investment, called the “cash value” component. The cash value amount of your premium is invested tax-free, and depending on the policy, you may be able to use the cash value component in several ways: You can borrow against it throughout your lifetime (in which case you pay interest to the insurance company), you can take out cash withdrawals (in which case your death benefit would be reduced accordingly), or you can use it to pay future premiums.
There are some caveats to mention here: You often need to pay premiums on a permanent life insurance policy for 10 to 15 years before there is enough cash value to borrow against or use to pay premiums. If you access the cash value of your life insurance, you’ll reduce your death benefit, and you also may have to pay fees or taxes, depending on the policy and how much you take out. And if you withdraw too much, your coverage could terminate.
Remember that life insurance provides your loved ones with a death benefit when you die, so you should always consult with your financial advisor before accessing the cash value funds.
How Much Life Insurance is the Right Amount?
When purchasing life insurance, you’ll want to make sure you have enough term life insurance to cover the expenses that your dependents will require until they are no longer dependents or until you are confident that you will have enough money saved up to cover the lifetime needs of those dependents.
If you have children with special needs or a non-working spouse, they will require a more extended period of care after your death, compared to a family with two incomes and children who will achieve their independence in their late 20s or early 30s. To determine the right amount of term life insurance, consult with us or a fee-only financial planner.
Suppose you plan on staying in your business well beyond the typical retirement age. In that case, if you are an indispensable part of your company’s continued success, or you will have estate taxes to cover upon your death, you should consider permanent life insurance. In that case, you’ll want to consult with us before you meet with an insurance agent to make sure you understand the terms of the policy you are buying and why you are buying it.
Your Trusted Advisor
We all have unique assets, liabilities, and family situations, so there’s no way to know precisely what types and amounts of life insurance coverage your family needs without a complete evaluation. Before you sit down with an insurance agent, meet with us to identify the appropriate life insurance policy for your particular situation. Schedule your appointment today to get started.
At Cheever Law, APC, we don’t just draft documents; we ensure you make informed and empowered decisions about life and death for yourself and the people you love, which starts at a valuable and educational Family Wealth Planning Session. The Life & Legacy Planning Session will allow you to get more financially organized than you’ve ever been before and make all the best choices for the people you love. If you have already completed your estate plan, we will review that plan at your Life & Legacy Planning Session (aka Family Wealth Planning Session) to ensure that it will work the way you intend and address any holes or gaps that may be present if circumstances have changed since you executed your plan.
To learn more about our one-of-a-kind systems and services, contact us or schedule a 15-minute introductory call today.