If you think about it, we insure a lot of things in our lives without giving it a second thought – our homes, cars, jewelry, and bicycles – our STUFF. When it comes to insuring our biggest asset, OURSELVES and our ability to generate income, many people are extremely underinsured and may not know where to start. Here is a basic summary of the types of life insurance coverage and why you might need it:
Types of Coverage
There are two basic types of life insurance – Term and Permanent. Term coverage is generally the less expensive option and is in place for a specific timeframe – usually 10, 20, or 30 years. Permanent coverage, as the name implies, will be in place until you pass away as long as the premiums are paid and the policy is performing as expected. Permanent coverage options can take many forms including Whole Life, Universal Life, Variable Life, and even policies that include a Long Term Care coverage rider.
Why would I need it?
Life insurance can be used in different ways, but the main reasons are income replacement, estate planning, and legacy:
Income Replacement – This is one of the most important reasons for obtaining life insurance coverage. If a family income earner passes away, his or her income stream stops. This can be devastating to the survivors as they still have to pay the mortgage, bills, food, and other necessities, not to mention paying for a funeral and saving for things like their retirement or college education. Life insurance is a tool to replace that income stream and help the survivors continue their lifestyle without financial distress.
It seems clear that the main household income earner needs some life insurance coverage, but what about a stay-at-home partner? It is a common misconception that a person working inside of the home does not need life insurance coverage. There are several financial factors to consider if the non-income- producing spouse passes away. The working spouse will now need to find childcare and potentially find transportation to take the children to and from school or daycare. If the working spouse frequently travels, they will need to provide overnight care for the kids. The surviving spouse may also need help with home maintenance, cleaning, and meal preparation. Losing a stay-at-home spouse can greatly affect cash flow and change the lifestyle of the existing family members if they are not appropriately insured. Term insurance is frequently used to cover income replacement because the term is identifiable and the cost is generally reasonable. For instance, you could structure the term around when your kids graduate from high school or college or around your expected retirement age.
Estate Planning – Everything you own is considered your “estate.” If you own a significant level of assets at the time of death, it is possible that you will owe estate and gift taxes on that value. This includes everything you own – your house, vacation homes, cars, investment accounts, etc. This could be an unwelcome surprise for your heirs, especially if they were inheriting non-cash assets like property and aren’t able to pay the necessary taxes. This can result in a fire-sale situation where your heirs would need to sell your assets in order to pay the taxes owed. The rules have changed on estate planning in recent years, so estate taxes aren’t as much of a hot topic anymore. In 2016, an individual can pass away leaving $5.45 million to heirs and not pay estate taxes. This means that a married couple can shield $10.9 million from federal estate and gift taxes when they pass away. Back in the 1990’s and early 2000’s, the exemption level was under $1 million, so many people needed to plan for how to pay the taxes that would be due after their death. If your estate value is above the exemption level, you can use life insurance to pay any taxes due at that time. If you need insurance to cover estate taxes, you would probably look into a permanent policy as opposed to a term policy.
Legacy – Life insurance can also be used to leave a legacy. You can leave money to your family of course, but you could also use it as a charitable donation when you pass away. You could simply name a charity as the beneficiary of the policy, or use different types of trusts to transfer ownership of your property to the charity. You would typically utilize a permanent policy for this type of life insurance need.
It is a good idea to meet with a financial planner to determine the type and amount of life insurance is right for you, your loved ones, and your specific circumstances. As life happens and your situation changes, you may need to adjust your life insurance coverage accordingly. Some events that could trigger a need for life insurance coverage or a change would include getting married, growing your family through birth or adoption, divorce, job change, or a change to your overall health situation. Once your coverage is in place, make sure you review it every few years (or upon a triggering event) to make sure you are adequately covered.