Life insurance confuses even the most financially savvy families. People of all ages approach their financial advisor with questions about life insurance: what is life insurance? Why do I need it? How does it work? Are there different types of life insurance? And how much life insurance do I need for my family?
Those questions are important. Life insurance — when leveraged well — is a huge asset to your financial plan.
It can protect your family, increase your legacy and even provide new opportunities for giving.
In this article we answer your questions and help you figure out how life insurance fits into your financial plan.
What is Life Insurance and How Does it Work?
Like other types of insurance, life insurance is a contract between you and an insurance company.
You pay monthly premiums and in exchange, the insurance company pays out a death benefit to your beneficiaries should you pass away.
What your beneficiaries do with this payment is up to them. (More on that later!) But in general, life insurance cares for your family after you are gone.
Types of Life Insurance
Term Life Insurance
Term life insurance is the most popular type of life insurance.
As the name suggests, this is coverage for a specific length of time (or term). Popular policies cover 10, 20 or 30 years. If the insured party dies during that term, the benefit is paid to the beneficiaries. If the individual dies after the term expires, there is no payout.
Your premium, the amount you pay, is based on your current health, age and life expectancy. The healthier you are (and the less chance the insurance company will have to pay out a benefit), the lower your rates will be.
Premiums are set at a fixed rate when your coverage begins. If your initial term expires, you do have the option to renew coverage, but your premium will be reassessed. That typically means you’ll have to pay a higher rate.
Term life insurance is more affordable than permanent life insurance, but it has no cash value. That means you can’t draw any money from a policy except for in the case of a death.
You can learn more about the types of term life insurance HERE.
Permanent Life Insurance
Permanent life insurance is exactly what it sounds like — life insurance that covers your entire life. As long as you pay your premiums, your family is always taken care of.
The main benefit of permanent life insurance is that it typically accumulates cash value. As you pay into your policy, you can borrow some of this money for things like a college education or retirement. This money earns a modest amount of interest and is tax-deferred. It is important to note that the portion of your premium distributed to cash decreases overtime.
Permanent life insurance is more expensive but can offer some additional value. You can learn more about the different types of permanent life insurance HERE.
Why Do You Need Life Insurance?
Many of the people that call us at West Michigan Advisors want to know, “how much life insurance do I need?”
The answer, ultimately, is that it depends. To know what coverage is right for you, you first need to ask why you need it in the first place.
When most people think of life insurance, they think about income replacement.
That’s because for most people, their greatest asset isn’t their investment dollars or even their home. It’s their ability to earn an income.
Life insurance is a way to protect that asset for your family. Should something happen to you, your family won’t suddenly find themselves in crisis without your income.
Income replacement is the primary reason for term life insurance. It is also the more common choice for younger families who still have much of their working life ahead of them.
Life insurance can also have tax advantages. This becomes especially important with changing tax codes and increasing state taxes.
As suggested above, the cash value in a permanent life insurance policy is tax-deferred —you do not have to pay money as your value accumulates. For this reason, some people see a life insurance policy as a smart place to invest their money.
With the right strategy, life insurance can also help you be more generous. It allows you to give more than you might be able to through cash alone.
Individuals have many options here. You can name a charity as a beneficiary, gift your entire policy, add a charitable giving rider or gift dividends. Each of these options allow you to help your favorite causes — and many of them help you save thousands on taxes.
A financial advisor can help you figure out the best option.
Transferring Your Legacy
Many people think of life insurance as a way to protect their family. But it can also be a smart way to pass on your legacy. You may choose to make it the primary way you give money to your descendants.
For example, some people use their IRAs to give to charity — that way they’re not taxable. They then use a permanent life insurance policy to leave their family a sizable legacy. Again, this wealth is transferred to beneficiaries tax-free.
Because of these advantages, a life insurance policy can help you leave a larger estate for your spouse or kids — without losing a big percentage to taxes.
How Much Life Insurance Do I Need?
Now we come to the big question: how much life insurance do I need?
As you’ve read this article, you’ve likely realized a few things need to be considered in your answer:
- Your own age and health
- How long you want to be covered
- Your number of beneficiaries
- The existence and status of other investments
That’s why life insurance is an important part of your financial plan. Yes, it can be a necessity, but it can also be a valuable tool.
It is best to talk with an advisor who has an understanding of your whole financial picture. That way they can integrate life insurance in the way that makes the most sense for you and your beneficiaries.
At West Michigan Advisors, we love the peace of mind the right life insurance policy gives our clients. It’s all part of how we take care of tomorrow so you can enjoy today.