One life experience most people are not prepared for is a death in the family. While facing the death of a loved one is never easy, one way to help ease some of the stress is to try to be prepared financially. The Virginia Society of Certified Public Accountants (VSCPA) says life insurance is one of the best ways to do that. However, more than four out of every 10 people do not own a life insurance policy, in any amount, according to BestLifeRates.org. Further, while cost is the primary reason given for not having life insurance, Millennials overestimate the cost by 213 percent and Gen Xers overestimate the cost by 119 percent, according to the 2015 Insurance Barometer Study by LIMRA and Life Happens.
When you think about life insurance, you may dismiss it as something only older people need. At its very basic, a life insurance policy is taken out on someone’s life that pays out when the insured dies, helping to financially protect dependents and loved ones. Insurance proceeds are used to pay ongoing expenses, educate young children, pay off mortgages and cover final expenses. People put off buying life insurance because they don’t want to think about their own mortality, but CPAs say it’s important to your family’s financial security. Understanding your options is the first step.
- Decipher the jargon. “Life insurance” is a broad term covering many types of policies in two main categories: term policies and permanent policies. Permanent life policies are divided into three categories: whole life, universal and variable life insurances.
- Term policies: Term policies are pure temporary insurance coverage purchased for a fixed time period such as one year, five years, 10 years or more. If the insured person dies during the insurance period, the amount of the policy is paid to the named beneficiary. At the end of the term, assuming the policy has not been renewed, the policy no longer has any value.
- Permanent life policies: Permanent life policies provide insurance coverage and build cash value you can borrow against. They are typically more expensive than term insurance.
- Whole life insurance: Whole life insurance has a set premium payment and builds cash value at a guaranteed rate of return.
- Universal life insurance: Universal life insurance is a flexible-premium, adjustable life insurance product that allows you to vary the premium payment within certain limits. The death benefit can be increased or decreased as defined in the policy without having to buy a new contract. Like whole life, the cash value can be borrowed.
- Variable life insurance: Variable life insurance is permanent insurance that builds cash value. What makes variable life insurance different is the cash value is dependent on the investment performance of one or more separate accounts. In other words, the policy owner is subject to financial risk, which may result in the loss of its cash value.
Life insurance coverage may be bundled (or combined) with other insurance policies. For example, the package may pair life coverage with long-term care coverage.
- How much should you buy and what will it cost? Figuring out how much life insurance you should purchase comes down to crunching the numbers and knowing your personal level of risk. You can come up with a number by either estimating the potential income for the rest of your life, multiplying your annual salary by the number of years left to retirement, or you can use the family needs approach. This method focuses on the amount of life insurance it would take to allow your family to meet its various financial obligations and expenses in the event of your death. With the family needs approach, you divide your family’s financial needs into three main categories:
- Immediate needs at death, such as cash needed for estate taxes and settlement costs, credit card and other debts, including mortgages (unless you choose to include mortgage payments as part of ongoing family needs), an emergency fund for unexpected costs and college education expenses;
- Ongoing income needs for expenses related to food, clothing, shelter and transportation, among other things. These income needs will vary in amount and duration, depending on a number of factors, such as your spouse’s age, your children’s ages, your surviving spouse’s capacity to earn income, your debt (including mortgages) and whether you’ll provide funds for your surviving spouse’s retirement; and
- Special funding needs, such as college funding, charitable bequests, funding a buy/sell agreement or business succession planning.
Once you determine the total amount of your family’s financial needs, you subtract from this total the available assets your family could use to defray some or all of their expenses. The difference, if any, represents an amount that life insurance proceeds — and the income from future investment of those proceeds — can cover.
Trying to figure out how much life insurance is enough isn’t always easy, and the amount will likely change with changing circumstances. Once a year, examine your family’s anticipated expenses in the event of your death and you will get a timelier, more realistic estimate of your life insurance needs.
Unfortunately, many people underestimate their insurance needs and are under-insured. Often, the purchase of life insurance is based on cost instead of what’s needed. By the same token, it’s possible to have more insurance than you need. You may have purchased a large policy during a particular point in your life, and then didn’t adjust your coverage when your insurance need was reduced. Both of these circumstances are reasons to review your insurance coverage periodically with your financial professional. Doing so can reveal opportunities to change your levels of coverage to match your current and projected life insurance needs. Agents use actuarial tables, which project your life expectancy and determine your costs. If you purchase a policy when you’re younger, the premiums are generally less expensive.
Follow these tips:
- Work with a reputable agent.
- Work with your professional advisers to help choose the right amount of coverage for your purposes.
- Understand the terms and costs so you don’t buy a policy that isn’t just right for you.
- Reduce your premiums by stopping smoking, losing weight, wearing your seatbelt and not having a dangerous hobby, like skydiving.
If you have a spouse or other dependents, it’s vital to have some type of life insurance in place. Depending on your specific needs, your life insurance policy can play an important role in your long-term personal financial plan. Talk to your CPA and insurance agent to help you decide.