Life Insurance

For many people, life insurance is probably the most unpleasant type of insurance to discuss. As is true of other insurance policies, when you buy life insurance, you confront arcane language, complex charts and tables, and pushy salespeople. However, pure life insurance offers one difference: The insured is not the primary beneficiary from the policy. Life insurance is really designed to protect the survivors of the insured. This is not to say that a life insurance policy yields no advantages while the insured lives. Nevertheless, the main reason to purchase a policy is for the death benefit, which you hope that your dependents collect a long time in the future.

If your family or other people depend on your income, you need life insurance to help them live without your support if you pass away. The insurance contract requires that the insurance company pay your beneficiaries a set amount, called the death benefit, if you should die for almost any reason. (For example, suicide is usually excluded for the first two to three years of a policy.) Your beneficiaries can receive the money in one lump sum, free of federal income taxes. The funds should be enough to replace the insured’s paycheck, cover daily living expenses, and pay the insured’s final medical bills and burial costs. In addition, the insurance proceeds should provide income for long-term needs such as retirement, estate taxes, or college costs.

The key question in buying life insurance is how much coverage your beneficiaries really need. You should determine this before you listen to insurance agents’ sometimes confusing pitches or the details of different policies. Unfortunately, assessing how much is enough is not a simple process because each family is different. No general formula exists. You will require more coverage if you have several young children and a nonworking spouse, for instance, than you will if your spouse earns a good salary and you have only one child.

The first step in determining your ideal amount of insurance is to examine your current family situation and your potential family situation. The following describe a few typical family scenarios, broken down into high-need, medium-need, and low-need categories:

High need. You will need a significant amount of insurance if you die as a:

  • Working spouse married to a nonworking spouse, with children. Life insurance proceeds should pay for your family’s living expenses and your children’s education and should replace your income as sole wage earner.
  • Working spouse married to a nonworking spouse, with no children. Your spouse should receive a death benefit that will generate enough investment income to replace your paycheck and cover his or her living expenses for the rest of your spouse’s life.
  • Single parent. Because your children depend on you totally for both shortand long-term expenses, life insurance proceeds should replace your income.
  • Business owner. If you are the sole owner of a small business or are in partnership with someone else, your life insurance proceeds should replace your income for your family and enable your partner to carry on with the business. A special arrangement called a buy/sell agreement can be funded with life insurance proceeds to smooth the transition for both your family and your partner.

Medium need. You will need some insurance if you die as a member of a:

Dual-income household, with no children. Though your spouse may be able to survive on his or her own if you die, he or she might have to adopt a significantly lower standard of living. The insurance benefit, if invested wisely, should permit your spouse to maintain a quality life.

  • Retired couple, with self-supporting children. Assuming that you have not set aside enough money in savings and investments, life insurance proceeds should provide enough income to maintain your spouse’s lifestyle.
  • Low need. You will need little or no insurance if you die as a:
  • Single person with no children. If no one depends on your income, you have little need for life insurance.
  • Nonworking spouse, with no children. Because a homemaker produces no income that needs to be replaced, your spouse should be able to maintain his or her standard of living if you die.
  • Young child. While the insurance on children is inexpensive, it is usually unnecessary because they do not support anyone—unless they happen to be supermodels or famous child actors.

As you can see, the common thread in determining need in all of these situations is whether survivors will have enough money to maintain their quality of life if the insured dies. Calculating how much insurance you need is where this whole process can get very complicated. For an exhaustive analysis, consult a good insurance agent, or run through some of the exercises available on software like Microsoft Money or Quicken. Such advisors will counsel you about your insurance needs; they sell no policies.

Next, determine your family’s ongoing future income and expenses if you were to die. When calculating income, include any benefits your family might be entitled to, due to your death, from government programs, such as Social Security and veterans survivor’s programs, as well as from life insurance provided by your employer. To learn how much these programs pay, call the Social Security Administration, the Department of Veterans Affairs (VA), or your employee benefits office.

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