The primary breadwinner works in the energy industry to support his wife and three young children. He has multiple mortgages, credit card debt, and nursing home expenses for his elderly father.
But like millions of Americans, he is woefully underinsured.
“If you die, I’m going to have three kids to take care of,” his wife laments. “I want you to buy some life insurance … please.”
After a pause, the dutiful husband agrees: “Sure, if it’ll give you peace of mind. But I’m not going to die for many, many years.”
Homer Simpson then proceeds to nearly decapitate himself while closing the bedroom window; he is subsequently deemed uninsurable.
While embellished for our amusement, Homer’s cautionary tale should resonate throughout Life Insurance Awareness Month in September. According to the life insurance research group LIMRA, 84% of Americans agree most people need life insurance, yet only 59% say they have some form of life insurance.
Why such an aversion to life insurance? For one, no one likes to think about the inevitability of death.
“Life insurance can be viewed as just an expense – something you have to pay for that you’re never really going to benefit from unless you die,” said Steven Sweeney, CFP®, CLU®, ChFC®, a senior sales consultant for Transamerica’s Advanced Markets Group. “You’ll hear people say, ‘You buy life insurance for the people you love, not for yourself.’”
Along with “jumbo shrimp” and “working vacation,” “death benefit” remains one of life’s great oxymorons. But modern life insurance products go beyond leaving a legacy for your loved ones.
“Life insurance is this big, broad topic.” Sweeney said. “There are a million different ways to go about it.”
Life insurance 101
Life insurance falls under two primary categories: term life insurance and permanent life insurance. Simple enough, right?
With term life, a policyholder buys a set amount of coverage (say $250,000) for an annual premium (say $500) that’s dependent on age and health considerations. The term generally runs anywhere from five years to 40 years, and the $250,000 is payable to the beneficiary if the policyholder goes to the big donut shop in the sky within the term period.
For healthy people in their 20s and 30s, a term life insurance policy can provide substantial coverage at a relatively low rate that remains locked in as they start a family and/or buy a home through the years.
Permanent insurance stays in place for life (provided the premiums are up-to-date). Using the example from above, the named beneficiaries receive the $250,000 payout when the policyholder passes away.
Because of the lifetime coverage, permanent life insurance tends to be more expensive than term life insurance, but the premiums may build cash value that can be accessed as a tax-free loan in later years, if necessary. Keep in mind that any money taken from the policy reduces the benefit if the policyholder dies.
This is just the tip of the iceberg when describing term and permanent life insurance. When considering both types, good health and youth are an applicant’s best assets. Unfortunately for Homer, he possessed neither when he applied.
How much is enough?
Figuring out how much coverage you need can be tricky, and there are a few schools of thought on how to calculate your needs.
- Human life value – Simply stated, this is a calculation of the total income someone would earn over a lifetime.
- Simple multiple – Take your annual salary and multiply it by 5 to 10 years. Many financial professionals use seven years as the generally accepted multiplier.
- Needs-based approach – Estimate college costs for any children and how much annual income you might need to replace. Add that to your existing mortgage balance (if any) for a final coverage amount.
“The worst-case scenario is you think you’re covered and you die and your family doesn’t have enough or they’re not as comfortable as you’d like them to be,” Sweeney said.
Life Happens, a nonprofit organization that cosponsored the Insurance Barometer Study, has an easy-to-use calculator that can help you figure out your coverage needs.
Group coverage vs. individual coverage
But wait a minute, Bart. I’m covered through my work.
Of the 59% of people who say they own life insurance, about one-third of them are covered solely through group insurance provided by their employer. While some insurance is better than nothing, workplace coverage might not be enough.
Many employers provide free coverage with a payout equal to one year’s salary. Workers then have the option to purchase additional coverage, with the premiums deducted straight from their paycheck. Group coverage is not portable, meaning it ends when you leave your employer.
“There’s a common misconception that your employer-provided coverage is adequate,” Sweeney said. “It’s either not enough coverage or there’s the possibility that if they leave that company, it’s not going to go with them.”
While workplace coverage is a nice perk, Sweeney emphasizes you shouldn’t count on it as your sole source of life insurance.
While life insurance is typically a way to hedge our bets against an early demise, not all policies require the policyholder to die before benefits are paid.
Some term life insurance provides early access to the policy’s death benefits if the policyholder becomes critically, chronically, or terminally ill. This is known as an accelerated living benefit, and the money can be used to cover expenses such as car payments, mortgage payments, groceries, and utilities.
“It’s an option on the table you wouldn’t have had otherwise for usually only 10% or 15% more of your usual premium,” Sweeney said.
Keep in mind, any accelerated benefit will reduce the policy’s death benefit.
Making the call
So what’s right for you? It depends. Consider:
- How old are you?
- Is there a history of poor health in your family?
- Do you have a mortgage, children, spouse, or partner?
- Do you need life insurance as a means of protection or a means of tax-deferral?
- Can you afford to pay more for the opportunity for your premiums to grow as investments?
- Is life insurance part of your retirement plan or simply a strategy to leave a legacy for your heirs?
That’s just a short list of questions. A financial professional or licensed insurance professional can help evaluate your situation and help you make the decision that’s right for you.
“It’s a conversation about what your circumstances are,” Sweeney said. “There’s no one formula. You want to get to the point where you’re comfortable, you’re protected, and you can sleep at night.”
Things to Consider
- Based on your debt obligations, marital status, and future financial goals, calculate how much life insurance you might need.
- Don’t assume your life insurance needs are covered simply because you have a policy through your employer.
- Talk to a financial professional or licensed insurance agent about what type of life insurance product and coverage is right for you.