Do I need life insurance? From simple protection to complex financial tools
Deciding whether you need life insurance is one of those milestones that signals you’ve stumbled into adulthood. Although an insurance agent might insist that more coverage is always better—likely influenced by their commission structure—the truth is more nuanced.
Life insurance is essential for many heads of households, especially those with children or a mortgage, but it’s not a one-size-fits-all solution. For some, it’s a financial safety net; for others, it’s an unnecessary expense. Your needs are shaped by your financial obligations, long-term investment goals, and those who depend on you.
Key Points
- Life insurance replaces your income after you die, a necessity especially if you have young children or a mortgage.
- If your estate is large enough to trigger the estate tax, life insurance can help your beneficiaries pay the bill.
- Insurance contracts range from simple to complex and expensive, and often involve a hard sell.
How life insurance protects your income
When you die, your income dies with you. If you have children at home or share a mortgage with a spouse or partner, the loss of income could make things difficult for those left behind. Life insurance pays money to your beneficiaries after your death, helping them manage expenses and maintain their standard of living.
The most basic type of life insurance is term life. You agree to pay a monthly or annual premium for a certain number of years, and if you die during that time, those you’ve named as beneficiaries receive money. The contract ends either when the time is up, if you stop paying premiums, or if you die during the coverage period. For consumers who are young and healthy, term life is a relatively inexpensive way to ensure that their families are protected against financial loss should they die within the term.
Tips for calculating your life insurance needs
Determining how much life insurance to buy can feel daunting, but a simple framework can help, depending on what you’d like the policy to accomplish. Consider these key factors:
- Income replacement. Estimate how many years your dependents would need financial support if you were no longer around. Multiply that by your annual income to get a baseline.
- Paying off debt. Add up the debts you’d want to eliminate, such as a mortgage, student loans, or credit card balances, to ensure your family isn’t burdened with them.
- Future expenses. Think about significant costs, such as college tuition or ongoing caregiving for a dependent, that would need to be covered after your death.
- Savings and assets. Subtract any savings, investments, or other resources your dependents could use to avoid buying too much coverage.
Calculating these amounts gives you a starting point for the coverage you might need. From there, you can adjust based on your family’s circumstances and priorities.
If your family relies on your income or the unpaid work you do caring for the household and children, you probably need life insurance.
When life insurance becomes more than just coverage
A common criticism of term life insurance is that consumers pay premiums without receiving any return unless they die before the term ends. The insurance industry introduced products designed to address this concern, though they also come with high commissions to pay salespeople.
One of these products is whole life insurance, which provides lifelong coverage as long you continue to pay the premium. These premiums are designed to exceed the cost of the death benefit in the early years, with the extra amount invested to build cash value. The cash value can be used to increase the death benefit, fund an annuity that provides income in retirement, or borrow against as a loan.
Over time, a common issue with whole life insurance became clear: The premiums can be significant, and missing payments means losing coverage. To offer more flexibility, insurers introduced universal life insurance, which lets policyholders vary their premium payments within limits. Paying more builds cash value, while paying less may reduce it. But any remaining cash value is forfeited upon death.
Insurance riders: Extra features or extra costs?
A rider is an optional feature you can add to a life insurance policy to customize your coverage. Riders often address specific needs, but at an additional cost. Common examples include:
- An accidental death benefit rider increases the payout if death occurs due to an accident.
- A waiver of premium covers your premiums if you become disabled and can’t work.
- Long-term care riders provide funds for long-term care expenses if you meet certain conditions.
Riders can enhance your policy, but they may not always be worth the extra expense. Choose a rider carefully to ensure you’re not being taken for a ride.
Collectively, whole life and universal life insurance are known as permanent life insurance, because the death benefit remains in place for the contract holder’s entire life (as long as the payments are kept up). Unlike term life, these policies don’t expire. Adding features, known as riders, increases the overall cost of the policy, which may result in fees or a higher monthly premium.
Reasons to choose permanent life insurance
For most consumers, purchasing term life insurance they can afford along with disciplined investing is a better choice than permanent life insurance. Permanent life insurance does essentially the same thing—providing coverage while building cash value—but with additional fees.
Still, there are specific situations where permanent life insurance, particularly whole life, may be worth considering. One reason is if you expect your estate to face inheritance taxes. As of 2023, the U.S. government taxes estates valued at $13.6 million or more. Life insurance can protect part of your estate from taxes or provide funds for your beneficiaries to pay the tax bill.
Another reason to consider permanent life insurance is to provide ongoing income for someone who depends on you financially. For example, a child with a disability that makes working difficult or impossible could benefit from the financial support life insurance offers.
The bottom line
Term life insurance is often the best choice for those with young children or a mortgage who need coverage. It’s relatively affordable, especially if you’re disciplined enough to invest the money you save on premiums by choosing term life over permanent life insurance. Permanent life insurance, while significantly more expensive, offers lifelong coverage and may make sense if you have specific needs, such as complex estate planning or providing for a dependent with long-term care needs.
Understanding your financial goals and circumstances can help determine what’s right for you. If you need guidance, a financial advisor can help you weigh your options while keeping your priorities in mind.
References
- Investment Products: Insurance | finra.org