Holland, Michigan Will, Trust, and Estate Attorney
What is life insurance?
Life insurance is a financial safety net for your family. It can be used to pay your final expenses, such as a funeral, burial, or cremation. It can also be used to pay off your financial obligations, such as a mortgage or other debts. Life insurance can also be a financial legacy for your family – it can pay for college, a vacation, or a down payment on a house. Life insurance is a pot of money that is left for your loved ones to use as their needs require.
So many kinds of life insurance… Which is best?
Life insurance is much like us – it comes in many different shapes and sizes. Each type of life insurance does slightly different things, which serve different needs, and offers a slightly different product. Generally, there are two classes of life insurance: term and permanent.
- Term life insurance is kind of like renting an apartment – you pay your premium each term, but don’t build any equity (cash value). Also, just like with an apartment, at the end of your lease (your term), you have nothing to show for the money you paid, unless you happen to die during the term (then your beneficiaries get the death benefit). However, term is often very inexpensive, so you can get a lot of insurance for not much money.
- Permanent life insurance is kind of like buying a house – you pay your premium each year, but you build cash value that you can borrow against the same way you build equity in a home. However, permanent life insurance is often extremely expensive for not much coverage, so it is often out-of-reach for most people, especially those just starting out or with young families.
Because each life insurance product serves a different need, there really is no “best.” What is most important is that you have enough life insurance to cover your needs. A financial advisor will help you sort out exactly how much you should purchase and what mixture is best for your situation.
Life Insurance, the basic breeds:
Within the broader categories of term and permanent, there are different types of insurance. Term insurance is term insurance, but permanent insurance can come in the form of whole life, variable life, and universal life to name a few. There are many further variations of permanent insurance within these categories, but these are the basic three.
- Term Life: is the least expensive form of life insurance. It offers a straight death benefit (payable on the death of the owner so long as the owner dies during the term) and has no cash value. Coverage is purchased for a specific length of time, such as 1-year, 5-year, 10-year, or even 30-year. The premium is paid each term and the policy can usually be renewed for more terms, but often at a higher cost. I.e. 1-year term that a premium is paid every year and the cost goes up every year.
- One of the best benefits of term life is that it is easy to get and doesn’t cost a fortune. An individual can get $250,000 or even $1,000,000 in 30-year term for a reasonable price. Of course, if the policy holder does not die within the term, there is no death benefit.
- Whole Life: often the most expensive form of life insurance. It is permanent insurance that offers both a death benefit and a cash value. Coverage is purchased at a certain price and that price is paid each year for the life of the policyholder (the cost never increases). The policy also builds a cash value that can be borrowed against as a loan.
- Variable life: is a form of permanent insurance that offers both a death benefit and a cash value. With variable life, the funds paid (the premiums) are invested in a variety of ways, which can grow the policy much faster. A variable life offers a guaranteed minimum death benefit, but, because of the investment of premium, can often be much higher than expected.
- Universal life: is a form of permanent insurance that offers both a death benefit and a cash value. Unlike in variable or whole life, the cash value of universal life grows tax-deferred. Additionally, the policyholder can determine how much of the premium paid goes to cash value and how much goes toward the death benefit, which makes it more flexible than whole life.
So how much life insurance should I have?
The breadwinner in the household should have the most insurance. Traditionally, this has been the husband, but times, they are a changin’. Now, with most families being two-income, it is important to insulate against the loss of half of the family’s income. This also keeps the surviving spouse from being forced to remarry right away just to pay the bills.
The formula for how much life insurance to have goes like this:
Each spouse should have enough life insurance death benefit to cover:
- All debt (including credit card debt)
- Funeral expenses (at least $10,000 here)
- College expenses for each child
- Living expenses to cover the lost income for the family until children are finished with college/on their own
If one or both spouses are retired, then omit the college expenses and include enough to cover the lost pension/retirement/miscellaneous income for the remainder of the surviving spouse’s life.
An unmarried individual (single, divorced, etc.) should have enough life insurance death benefit to cover:
- All debt
- Funeral expenses
- College expenses for each child (if single parent)
- Living expenses to cover the children until they are finished with college
You can always have more coverage, but this is the bare minimum each person should carry. That does not mean that all the insurance should be in one form of insurance or that cash value should be taken into consideration. The above should be used to calculate the minimum death benefit that the policyholder’s beneficiaries should receive upon the death of the policyholder. With any permanent life insurance that builds cash value, the cash value should be considered a bonus since it is only available while the policyholder is alive.
Ideally, you should have some term life insurance and some permanent life insurance. The term insurance will cover the bulk of the needed minimum death benefit as it is least expensive. Once major expenses are paid off (such as the mortgage and kid’s college expenses), the minimum death benefit needed decreases. By this time income has usually increased as well, so this is the time to invest in permanent life insurance.
However, when determining whether to purchase term or permanent life insurance, you must also consider how healthy you are. Permanent life insurance policies often require more difficult health exams and will penalize unhealthy individuals, so it is best to buy when you are still healthy and the price is the lowest. While we don’t have a crystal ball to see into the future, look to your family medical history for certain risk factors. For example, if all your female relatives developed cancer at age 45, purchase your permanent life insurance before that age. Your family history is the best indicator of your future health when also considering your lifestyle and diet.
While there is no single one-size-fits-all number or approach, typically you should carry as much life insurance as you can afford and no less than is required to pay off the formula above. These costs can change over time, however, and expenses can add up – right now, final expenses can cost upwards of $10,000 – so it is best to plan generously and have more life insurance than you think you need. Your financial advisor can make help evaluate your situation and make sure that you have enough coverage in the right products to help you meet your goals.
Does it cost a lot to hire a financial planner?
No! Financial planners typically earn their fees from the products they sell – the companies pay them a commission for selling the product. Typically, this means that you will pay nothing (or very little) out-of-pocket for the services of a financial planner.
So how do I find a financial planner to help me?
Most investment and brokerage firms have financial advisors on staff. Look for an advisor with the initials CFP (certified financial planner) after their name – this means they specialize in financial planning and are not just out to sell products. Because financial planning is an important part of a healthy estate plan, VanderBroek Law, PLLC, has several well-respected financial planners we work with and highly recommend; however, financial planning services are not included in the cost of your estate planning and the financial planners are not affiliated with VanderBroek Law, PLLC.