Life Insurance: What Kind and How Much Should I Have?

floating life preserver

Planning for the future is important to ensure you are protecting yourself, and your family. Life insurance can be a key part of that protection.

You should consider purchasing life insurance if your death would create a financial hardship for people you leave behind, whether it’s a spouse or partner, child or other dependents.

If you have people who financially depend on you, you may need insurance to cover your current and future obligations (ie. mortgage, childcare, college, living expenses, etc) if something happens to you. Life insurance helps ensure that your family will be financially protected if you die.

If you’re single and no one depends on your income but you, you may not need life insurance at all.  

If you do have people you want to protect, the next step is figuring out what type of insurance you need and how much. You may have some life insurance coverage through your employer but keep in mind that is usually dependent on continued employment there. If you leave your job, you lose the insurance coverage. For that reason, most financial advisers recommend that if you feel you need life insurance, you should have a policy outside of work. So what kind should you consider? It depends. The two most common types are “term life” and “permanent life” and primarily differ on how long they provide coverage.

Term Life is considered to be the most basic type of life insurance with coverage purchased ahead of time for a pre-determined length of time.

You usually buy term life insurance in five year increments from 5 to 30 years, or even longer. The longer the policy, the more the insurance will cost since it means more of your life is covered. Once the term is over, you’re no longer covered. Term life provides for a death benefit only, there is no cash surrender value or other living benefit. This makes term life insurance an affordable way to provide a safety net, especially for those who are younger and in good health at the time they apply for the coverage. You are locking in a fixed premium for a fixed period of time. At the end of the policy, if you want to renew, you will need to re-qualify for a new policy at your then-current age and health status. At that time, the premium on a new life insurance policy will probably be a little higher (the older you are the more expensive you are to insure). This is why people typically choose the longest policy appropriate for them; re-insuring later is more expensive.

So how long of a policy should you consider? Think about the time frame of the financial obligations (mortgage, college, etc) you want to cover. You usually want the policy to continue until your last major obligation is taken care of.  There are calculators available online and insurance agents also have tools to assist with the amount of coverage and the term you may need. If you die while your term policy is still in effect, your beneficiary will be paid the face value of the policy. If you die after your term policy has expired, there is no payment to anyone.

Permanent life insurance is different from term insurance because it offers both death benefit protection and a cash component (considered an investment) in one policy.

Permanent life insurance is typically used as a planning tool to cover estate taxes and leave an inheritance. It also differs from term insurance because, as the name suggests, it does not have a fixed time limit. Rather, it’s intended to last for the remainder of the insured’s lifetime (provided you continue to pay the premiums), however long that life is. So, why doesn’t everyone get permanent life insurance? The cost. Premiums are much higher than term life because there will be a death benefit paid at the end, so permanent life is much more expensive.

The simplest type of permanent life insurance coverage is whole life where the premium amount is locked in and remains the same throughout the life of the policy.

So, if you buy a whole life policy at a very young age, you’ll still pay the same premium when you get older, regardless of your age or declining health. At the beginning of owning a whole life policy, the cash value portion will grow slowly because the majority of the early premium dollars go towards paying the agent’s commission and the insurance costs. However, over the years, the cash in a whole life policy can steadily grow, and sometimes (depends on your policy) offer a minimum guaranteed rate of return in the form of dividends paid to you. The dividends are typically not taxed because they are considered to be a return of premium to the policyholder.

Another form of permanent coverage is universal life. This type of life insurance also provides a death benefit and a cash value component where the funds are allowed to grow tax-deferred.

Universal life insurance is considered to be more flexible than whole life coverage because you can choose (within certain guidelines) how much of your premium will go towards the policy’s death benefit, and how much will go towards the policy’s cash value. The cash portion of both whole and universal life can, once built up, be borrowed against, withdrawn or used to pay the premium. But this will reduce the future death benefit if not repaid. For both whole and universal life, the face value of the policy is paid to your beneficiaries at the time of your death. As for any cash value remaining in the policy, it may be added to the death benefit or forfeited to the insurance company depending on your policy.

Determining which type of life insurance policy is right for you is a personal question that depends on a lot of different factors. If you just want to cover your financial obligations for a period of time, choose an amount that will cover those and go with a term policy for a period that will cover that. It’s much cheaper and you can invest the additional money you would pay for a permanent policy elsewhere. If you want life insurance for as long as you live, you would want to consider a permanent policy, just remember it is much more expensive. You should consider the difference in premiums you’d pay throughout your life when making this choice.