Hello everyone and welcome to this month’s Ask the CFP® segment. This month’s question is, “How much life insurance do I need?” As with many financial questions, the answer is unique to each and every client.
Before we talk about how much life insurance is needed, let’s talk about the two main types of coverage: term and permanent.
Term life covers the insured for a specified amount of time, and popular options are 10, 20, and 30 year terms. If the insured passes away during this term, the insurance company will pay the death benefit to the named beneficiaries in the life insurance contract. If the term expires without the insured person passing away, there is no financial benefit or payout from the policy.
Permanent or “whole life” insurance comes in many varieties, and as the name implies, is meant to cover the insured for their “entire” life. These policies pay a stated death benefit and usually build up a cash value inside the policy that can be accessed by the owner. As long as the premiums are paid by the policy owner or by the dividends generated by the contract, the policy will remain in force.
Now that we’ve talked about the major types, let’s discuss how we determine the amount of death benefit needed. If someone passes away prematurely, life insurance is designed to help replace the income that they would have generated over their lifetime. It can also provide liquidity to purchase an owner’s share of a business, or to pay an estate tax liability.
For example, let’s say a young professional is married, has three kids, a mortgage, car payments and is just beginning to save into retirement and taxable accounts.
In this instance, the young professional has a lot of debt, plus a long stretch of wage-earning years expected. If something tragic were to happen to them, their spouse and kids would lose household income, and could still be responsible for the debt.
Taking out a term life policy would provide a death benefit to help the surviving family members pay off that debt and generate income.
Working with a financial planner, the young professional could assess how much death benefit is required to pay off all debts, fund any future goals, and leave enough of a nest egg to either supplement or cover their annual income.
Over time, the plan should be to accumulate more wealth and reduce liabilities. If the same young professional matures, has saved diligently, and their kids have finished college, their pure need for term life insurance changes.
Permanent insurance can be useful for business owners and families with estate tax liabilities. The amounts needed in these policies are usually calculated by performing projections as to what a person’s share of a business may be worth, or what a family’s estate tax liability may be. Additionally, some clients may wish to have a policy that accumulates a cash value over time as a source of potential income in retirement that is not subject to market risk.
Life insurance is one of the many components to a solid financial plan, and assessing how much is needed can require a holistic calculation depending on your unique needs.
If you have a question about this topic or have a question about a future video, please send it to pracen@monetagroup.com. Thanks for watching and we’ll see you next month.
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