Getting a Life: Insurance in Case You Aren't Around

Adulthood comes with all kinds of financial milestones: your first credit card, your first auto loan, your first mortgage.

And then there's your first life insurance policy, which may be the most significant milestone of all. After all, buying life insurance signals you now have folks who depend on you financially, whether it's young children or a spouse who doesn't work.

Indeed, this goes to the heart of what life insurance is all about: helping your family survive financially if you are no longer around and pulling in a paycheck.

What if you don't yet have anybody who depends on you? What if your family would be fine financially, even if you did pass away? What if the kids have grown up and left home? There is a good chance you don't need a life policy, unless you're using it for estate-planning purposes.

Calculating coverage

One rule of thumb suggests your coverage should be equal to five to seven times your annual salary. For instance, if you're earning $50,000, you might purchase a $250,000 to $350,000 policy.¹

In truth, this may be far more or less than you really need. To get a better handle on the issue, start by considering how long you will need coverage—and what expenses lie ahead. If you have a newborn, you might be looking at two decades of expenses, concluding with the hefty cost of college. The implication: You may need more than seven times your salary.

You should also, figure in your current savings and whether your spouse works. If you have a decent-size nest egg and relatively modest debts, perhaps you don't need quite so much coverage—and perhaps you can get by with a policy equal to five times your salary or even less.

Even if you have the right coverage today, things can quickly change. Your family may grow, and your income may climb. As your income climbs, your standard of living rises and your family grows, you may find you're woefully underinsured.

On the other hand, if you are saving regularly, your wealth should increase over time, so maybe today's policy will continue to be adequate. Either way, every few years, you should give some thought to your life insurance—and consider whether you need to buy more or can cut back coverage.

Picking policies

Once you settle on how much coverage you want, you'll have to decide what type of policy to buy.

Two popular types of life insurance are term and permanent:

Term

• Covers temporary expenses, like a mortgage
• Choice of coverage length between 10 and 30 years
• Primarily designed for younger families with more temporary needs
• Typically more affordable than permanent products

Permanent

• Covers lifelong needs, like estate planning, supplemental retirement income, final expenses
• Coverage for your entire life so long as policy stays in-force
• Primarily designed for those with lifelong needs or a desire to cover final expenses

Term policies often cover a fixed number of years, such as 10 or 20 years. You might decide you and your spouse will have ample income from Social Security and your savings when you retire in 10 years. But you want coverage between now and then, so you buy a 10-year term policy. Your annual premium will be based on factors such as your health history, age, and gender.

Many term policies offer level premium payments, which means the payments will stay the same during the term of the policy. If you die before the end of the term, your beneficiaries receive a death benefit. At the end of the term, you may have the option of renewing the policy at a higher premium, reflecting your more advanced age, or converting it to a permanent policy without evidence of insurability. What if you let the policy lapse by not making payments? The coverage is over—and you get nothing back.

Enter permanent insurance, also known as cash-value life insurance. As its various names imply, these policies provide permanent coverage while the policy is in-force, and the policies can build up cash value over time.

This, of course, comes at a price. If you took out a term and permanent policy at the same age, the premium on the permanent policy would be higher than the premium on a term policy with a comparable death benefit.

The higher premium goes, in part, toward building up the policy's cash value. In the early years of the policy, there's usually little cash build-up, because the bulk of the premiums go toward paying for pure insurance and other costs. In fact, if you surrender a cash-value policy in the first five years, you likely won't get much, if anything, back.

If you persist, however, a growing portion of your premiums should be credited to the policy's cash account, so the policy starts to accumulate cash value.

Renting insurance

So, which is better, term or permanent? Fans of permanent insurance sometimes dismiss term insurance as the equivalent of "renting." But for many folks, renting isn't such a bad idea, for three reasons.

First, because permanent insurance at the same age is generally more expensive, you may find the only way you can afford it is to skimp on coverage and buy a permanent policy with a lower death benefit.

Second, while the idea of building up cash value is appealing, you may have far better ways to invest your money.

Finally, you may find you don't need permanent coverage. Yes, you might require a lot of coverage when your children are young. But unless you're using life insurance as part of your estate plan, you may need less coverage once the kids leave home. Not sure which type of insurance is right for you? Consider consulting your Wealth Advisor.