When the first U.S. life insurance company, the Presbyterian Ministers’ Fund, opened shop in 1759, some people were outraged at the idea of putting a monetary value on human life. But as the public saw widows and orphans of ministers benefit from the insurance, sentiment shifted.
Today, life insurance is widely accepted as a valuable tool for protecting your family’s future. Indeed, 51% of American adults have coverage. The right policy can replace your income, pay off your debt and finance your children’s education, thus leaving your family financially secure when you are no longer around.
Since September is life insurance awareness month, we’re sharing several facts we want you to know about life insurance.
1. Life insurance isn’t just for people with partners or children. It’s for anyone who needs to protect assets. You may read about life insurance being used as an investment, but here at Sunflower, we believe insurance should be used as protection.
In general, you may want to consider purchasing a life insurance policy if you are the main breadwinner in your family, have debt such as a mortgage or school loan, own a business, care for your parents or other family members or have children. It may also be a useful way for you to leave an inheritance.
2. There are two main ways to figure out how much life insurance you need: the needs-based approach and the human life value approach. We recommend the needs-based approach.
The needs-based approach focuses on replacing your income and taking care of other financial obligations and future financial goals. It takes into account your income, burial expenses, debts, and goals like paying for your children’s education.
Here’s an example using the needs-based approach. Stella is 45 years old, a single mom, and plans to retire in 20 years. She earns $300,000 per year. Her expenses are approximately $150,000 per a year. She expects her expenses to grow 3% every year. Her daughter, Sarah, who is 14, plans to go to college in four years and graduate in four years. The college cost is $350,000. Stella’s mortgage is $400,000 and her house is worth $600,000; however, her wish is to sell the house instead of paying off the mortgage and passing it to her daughter debt-free if she dies. She has no other debt and modest savings of $100,000 in a brokerage account and $200,000 in a 401k. If Stella dies, she wants to make sure there are enough assets to cover Sarah’s living expenses until she goes to college, the full cost of college, and $100,000 of assets available for her daughter to start in life after she graduates.
- Expenses for 4 years (until child goes to college) $646,370
- College costs for 1 child + $350,000
- Assets for Sarah + $200,000
- Funeral and burial/cremation expenses + $10,000
- Probate fees + $5,000
- Total amount needed: $1,211,370
Assuming that Stella’s current assets are approximately $460,000 ($300,000 + potentially $160,000 proceeds from the sale of the house adjusted for sale cost), she will need $751,000 in life insurance, which should be rounded up to $1 million.
The human life value approach focuses on replacing the insured person’s income over a period of time minus the insured’s living expenses (clothing, food, transportation, insurance, etc.) and annual taxes; the total should be about 30% of the insured’s income. Keep in mind this calculation doesn’t take into account debts or future financial goals.
3. In most cases, the death benefit can be tax-free to your beneficiary.
The IRS says individual life insurance proceeds aren’t included in your beneficiary’s gross income and aren’t reportable. The beneficiary pays tax only on any interest received. However, if you have group term life insurance through your employer, the amount of the policy coverage over $50,000 is taxed as ordinary income to the beneficiary, according to the IRS.
4. Life insurance proceeds usually pay out in 14 to 60 days.
Life insurance claims pay out fairly quickly – likely faster than the time it could take to access other funds or liquidate assets to pay for a funeral and other final expenses, like medical bills. Estates can take months and years to settle, tying up needed funds.
5. The cost of an individual life insurance policy is based on your age and health condition, but if you can obtain life insurance through your employer, this will be the cheapest option – and you won’t need a medical exam.
The younger you are and the healthier you are, the lower your monthly premium will be for your life insurance policy. If you have a health issue, though, you will have to pay more for your monthly premium on an individual life insurance policy. Whether you have a health condition or not, the cheapest way to obtain life insurance is through an employer-sponsored group insurance plan, which does not require a medical exam. However, be aware of tax consequences and the fact that you can’t take a group life insurance policy with you when you leave your job.
6. There are different policies to fit different needs, including policies that are useful if you own or co-own a business or have specific estate planning goals.
The most common types of life insurance policies are term and permanent. Term life policies offer coverage for a specific number of years, while permanent life policies offer coverage for your entire life.
Term insurance is vastly more affordable than permanent insurance. The reason permanent life insurance is more expensive is because it covers the entire life, versus a period of time like term insurance does. There are different types of permanent life insurance; whole life is the most popular one. There are also universal life, variable life, variable universal life, and family life (second-to-die policies).
One of the benefits of permanent life insurance is that it accumulates cash value that grows tax-free and can be a useful source of funds while you’re alive. There are also variations on permanent life policies that allow you to change your monthly premium payment, invest your cash value, and adjust your death benefit amount.
Permanent insurance may be a good fit in certain situations, such as if:
- You have a child with special needs, then a permanent life policy can help fund a trust for their ongoing support after you die.
- You want to ensure your beneficiaries will receive an inheritance.
- You co-own a business and want to fund a buy-sell agreement to ensure a smooth ownership transition and to give your family financial security.
- You and your spouse want life insurance for two people that pays death benefits only after the second person dies.
However, one has to be careful when selecting a permanent life insurance policy. Permanent policies may have a high level of complexity in addition to expenses. Universal and variable policies require careful monitoring to ensure the cash value performs well and the policy stays in force, making them riskier than term life policies. If you borrow from the cash value and don’t pay it back, the insurer typically reduces the death benefit by the same amount. Working with a qualified independent insurance agent is critical when selecting a permanent life insurance.
Life insurance can be beneficial for you and those you care about, but there are many life insurance products out there, so we urge you to be careful and do your research. As always, if you have any questions about life insurance, feel free to get in touch with us at info@sunflowerfp.com.
IMPORTANT: Sunflower Financial Planning does not sell insurance or receive any compensation related to insurance products. This article is for educational purposes only.
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