Life Insurance: How Much and What Type To Own?

Do you need 5 times your income? Or do you need 10 times your income?In my experience, if you ask stupid questions you tend to get stupid answers.The real question you should be asking yourself is… If I die tomorrow, what do I want financially for the loved ones I will leave behind?Will your spouse need an income? How much? For how long?If so, how much money does it take today to provide that amount of income?What assets do I have to help offset that number?Are there any debts that must be paid off?Will your kids need money to pay for college?Is there a parent or another family member that depends on you?Do you want to leave money to your church or Alma Mater?Once you know the answers to the above questions, work with a qualified, unbiased professional like a Fee-Only Certified Financial Planner who can help you determine the correct amount of life insurance you really need.Don’t use rules of thumb to plan your financial life! Here’s why:Let’s assume you die tomorrow, and you need to replace your current income of $50,000 for the next 20 years to allow your husband/wife and kids to keep their same lifestyle without having to struggle. If you used the “rule of thumb” of 10 times your income when you bought your life insurance, your surviving spouse and kids will most likely run out of money in 15 years or less. Feel free to email me and I would be happy to send you the hard data.What Type of Life Insurance Do You Need?Let’s start off with the basics. There are two main types of life insurance: Term and Permanent.Both are conceptually easy to understand. Term Life Insurance covers you for a specified period or term, like 20 years for example. Permanent Life Insurance covers you permanently or for your entire life, or at least it’s supposed to. Permanent Life can have many sub-names like whole life, variable life, universal life or single premium life which all work differently.When you purchase Term insurance, you are only paying for the cost of insurance which is usually very inexpensive. In a Permanent policy, premiums are usually substantially higher than term. Some of the premium goes towards the cost of insurance and the remainder builds in an account called the “cash value.” Cash values typically grow tax deferred.You have probably heard all the media “hubbub” about which type of life insurance you should purchase. Radio show pundits and magazine articles tell us to only purchase term, or whole life is a bad investment, or own term and investment the difference.Are those things really true? Is it really that simple? What’s the truth?Well, honestly the type of life insurance you should purchase depends on many things. Some people only need term but others may need permanent.Tell me exactly how long you will need life insurance and when you will die, and I can tell you the correct type you should own. But like most other financial planning decisions, we must make some assumptions or best guesses about the future. But it’s very difficult to know when you are 20, 30 or even 40 what your financial life will really be like at age 60.Here are some truths:
Most permanent policies are junk! But not all.
Any type of life insurance is usually better than NO life insurance.
Most people should buy life insurance for protection only NOT as an investment.
Most people who end up buying the wrong type of life insurance got their advice from an insurance agent, not an objective financial planner.
This issue is way to complex for me to cover every detail in a blog post. My hope here is to get you to understand the basics so you can go hire a professional to help you that isn’t a financial sales person.You most likely need Term if:
You are just starting out
Have no discretionary income and/or low net worth
It’s very easy to forecast the length of your insurance need (10 years left on a mortgage for example)
Have a very limited amount of savings left over for retirement
You simply can’t afford permanent insurance, even it were a good deal
When Permanent Life may be a fit:
Very strong, predictable cash flow
High income earner
You have exhausted all possible retirement savings vehicles (401k, Roth, etc.)
Will have Estate Planning liquidity issues
It’s very hard to predict the age you will no longer need life insurance
You just want your life insurance to be there when you die!
You have done your research! Not all life insurance policies are equal!
You understand all the workings of the policy (expenses, interest rate, etc)
Why does Permanent Life insurance get such a bad rap? I believe most people fear what they don’t understand. And Permanent insurance can be extremely difficult to understand. Also, most Permanent Life policies have too many internal expenses which can make them a terrible deal. But some companies do a pretty good job of keeping internal costs down, therefore increasing the internal rate or return on your “cash value.”Here is one concept:Most term polices never pay a death benefit because people out live them or cancel them. Let’s say you compare 2 options: 1.) invest money in a taxable investment OR 2.) buy permanent life insurance where your policy builds cash value. If the cash value of your life insurance net of expenses could earn more than your investment account net of taxes, then you would have more money inside the cash value. OR vice versa. Sounds simple, right? Not exactly!You want to make sure you are comparing apples to apples. If the cash value grows at a fixed rate, then compare it to fixed income assets in your investment account. If your investment account is invested in stock mutual funds, compare it to a comparable allocation in Variable Life. This is where the media falls short on helping you understand Permanent life insurance. They try to compare fixed rate cash value insurance to the stock market over the long-term. That’s like comparing a Porsche to a Subaru!But it’s not all about the cash value rate of return. What about the rate of return on the death benefit? Like I mentioned earlier, this issue is far too complex to cover all the points here!Here is your take away. Term Insurance is right for many Americans. Some types of Permanent policies may be a fit for others. It just depends on the unique situation of the individual. This can be a very confusing area. Seek out unbiased, objective advice from a Fee-Only Certified Financial Planner.

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