Term Life InsurancePosted on September 14th, 2010 William No comments
When other people rely on your income, one of the most important things you can do is to purchase life insurance. Until you have a sizable estate, this is the best way to ensure that your family will be taken care of should something happen to you.
Term Life vs Whole Life
There are two main types of life insurance: term life and whole life. A term life policy is simply life insurance, nothing else; you buy it for a term of up to 30 years and if you die during that term, it pays out the benefit. Whole life combines life insurance with an investment component. Most financial experts recommend that you always prefer term life insurance, as you will almost always get a better return taking the difference in cost between the term and whole life policies and investing it separately. While investments and insurance are both part of a balanced financial plan, they should be handled separately, not together.
Generally the only time you would want to buy whole life insurance is later in life, when you often won't qualify for term life; however, if you start saving early, by the time you pass 50 you'll no longer need life insurance as you should be debt-free and your retirement savings will be sufficient to provide for your family should you pass on. Another (rare) occasion when you might want whole life is to use it to pay the taxes on your estate; this applies only when you expect to leave an estate worth over $3.5 million, and works because money taken from a life insurance policy (provided it is paid for with after-tax dollars) is currently exempt from income tax. Whole life insurance is often very popular with insurance salesmen, due to the high commissions.
How Much Does Life Insurance Cost?
Generally, not as much as you'd think. When you buy a term life policy, you can lock in the same rate for up to 30 years (although it will increase drastically after that). The author of this post, for example, has a $250,000 term life policy that will run until he turns 50, at which point the premiums will still be the same as they are today. Naturally, the longer you lock in the benefits for, the higher the annual premium cost will be as it would otherwise become much more expensive as you get older. Thanks to modern medicine, most people won't die before they reach 50, which allows insurers to keep their premiums for younger people quite low. (Of course, the fact that there is a ton of competition in this market helps as well!)
How Much Life Insurance Do I Need?
You should have enough life insurance to replace your income for whoever is relying on it. If nobody is relying on you, it may be sufficient to ensure you'll leave behind enough money to pay off any debts and pay for your funeral costs.
Suppose you do have people relying on your income. A good amount is enough to pay off your debts and provide enough income for your family to life on. The 4% rule says that you should generally be able to avoid running out of money if you withdraw no more than 4% of your retirement funds the first year, and 4% adjusted for inflation each following year; in other words, determine the amount you'll need each year and save 25 times that amount. So if your spouse works, for example, but you'd like to provide her with an extra $20,000 per year as well as pay off a $200,000 mortgage, you'll need to purchase ($20,000 x 25) + $200,000 = $700,000 in coverage.
How Long Should I Keep My Insurance?
As long as you need it. A good rule of thumb, assuming you're starting young, is that you should be financially free by the time you hit 50: no debt and sufficient savings that your spouse could life off of them if something were to happen to you. In that case, you no longer need life insurance. Of course, in practice you may or may not hit that goal. Just buy life insurance for whatever term feels right for you, and keep it until the end of that term; even if you become financially secure a few years early, the premium on your insurance will be effectively insignificant by that point, so you might as well keep it.
What About Joint Life Insurance?
When there are two breadwinners in the family, it generally makes sense to have a life insurance policy on each of them as they both contribute to the expenses of the home. While just getting two separate policies generally works perfectly well, there's also another option called Joint Life or First to Die, which pays when either person named on the policy dies. The idea is that regardless of who dies first, the surviving spouse will no longer need life insurance, so the second policy would be redundant. There are also survivorship, or second to die, policies that pay only when both (or all) insured parties have died; this is useful when the surviving partner will not need any additional money, but will want to leave behind a large estate. While these arrangements are less flexible than buying separate policies, they'll generally have lower premoums and may also have easier underwriting requirements.
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