If you have a partner/spouse, child, or elderly parent dependent on your income, you have a need for life insurance. The question: “Am I keeping up with the need?” If you are not checking your need versus your coverage on a regular basis, you may be putting your loved ones in a precarious situation.
Welcoming a new child to the family or purchasing a new house are primary examples of life events that should automatically trigger a review of your existing life insurance. If it has been a few years since you have reviewed your coverage, asking the following questions will provide a good starting point for evaluating life insurance needs.
How much do I need?
Quantifying how much life insurance coverage is necessary can be a bit complicated. When determining coverage need, the following factors are important to considered: existing life insurance, annual family living expenses, total outstanding debts, and Social Security survivor’s benefits. Other critical assumptions include a funding timeline and inflation rate used for ongoing living expenses. Let’s look at a simple example.
Katie, age 31, is married and has one child, age 3. Katie has an existing 20-year term life insurance policy with a $250,000 death benefit. Katie wants to provide for annual family living expenses of $36,000, more than the Social Security survivor’s benefits her husband would receive, until her child’s age 18. She would also like to pay off their mortgage (current balance of $250,000) and their car loan (current balance of $15,000).
Considering the above information and a 3% inflation rate on annual living expenses, Katie has a total life insurance need of $935,000. After subtracting her existing coverage of $250,000, Katie needs additional life insurance amounting to $685,000. The calculation is broken down below:
- Current mortgage value: $250,000 plus,
- Current car loan value: $15,000 plus,
- Annual living expenses: $36,000 (for 15 years; 3% inflation rate)
Total Life Insurance Need: $935,000
Other factors to consider when evaluating life insurance should include the value of available assets (cash, investment accounts, and retirement accounts) and any future funding goals (like providing for future college expenses for children). In addition, working with a CERTIFIED FINANCIAL PLANNER™ (CFP®) or a Chartered Life Underwriter® (CLU®) to determine the appropriate amount of coverage for your specific needs is recommended.
Do I have the correct type of coverage?
Level Term Life Insurance. The simplest and most appropriate type of life insurance for most individuals is level term life insurance. Term life insurance guarantees that beneficiaries are paid a predetermined death benefit if the insured dies during a set period. Once the term of the policy expires, the death benefit also expires. Typically, this type of life insurance offers terms ranging from 10 to 30 years. Term life insurance is usually the most inexpensive option compared to permanent life insurance.
Permanent Life Insurance. Whereas term life insurance provides coverage for a stated period, permanent life insurance covers long-term insurance needs. Permanent life insurance, such as whole or universal life, remains in force as long as necessary premiums are paid. Permanent insurance often combines a cash value component, which some equate to a forced savings vehicle. However, the underlying expenses associated with these types of policies can ultimately hinder the investment growth of the cash value. Permanent life insurance premiums are typically more expensive than term insurance, and premiums can be difficult to sustain over a long period of time.
Employer Group Insurance. In addition to level term insurance and permanent insurance, many individuals have life insurance through employer-sponsored group policies. Employers often provide a certain amount of coverage to employees for free with the option for employees to purchase additional coverage. Employer-sponsored life insurance can often be a cost-effective way of obtaining insurance since the group component can lower overall premiums. Additionally, employees may have the option of getting coverage without medical underwriting, which can be an attractive option for older workers or workers who have known health conditions. However, group coverage ends when employment ends, so purchasing coverage outside of employer-sponsored insurance is recommended.
Determining life insurance needs with the help of a professional is a good option. Remember that level term life insurance is generally the appropriate type of coverage for most people. If you think you need additional insurance coverage – act fast! Policy premiums increase as we get older due to underwriting. Lock in less expensive premiums by getting coverage sooner rather than later.
Abby VanDerHeyden, CFP, is a Wealth Advisor with Bedel Financial Consulting, Inc., a wealth management firm located in Indianapolis. For more information, visit their website at www.bedelfinancial.com or email Abby at AVanDerHeyden@bedelfinancial.com.