Buying life insurance is a daunting task and can be very tricky. Most individuals are sold a catch-all life insurance policy rather than one that actually meets their specific needs. When choosing how much and what type of policy you need, it’s important to break down the reasons why you need it.
For example, there is a big difference between buying life insurance with the highest death benefit you can afford vs. buying life insurance with the highest cash value you can accumulate in the policy. These two objectives are very different and the design of these two policy types will be completely different as well. Most individuals don’t understand this and are typically sold into a policy that might not be right for them now, or in the future.
Three Steps to Breaking Down Life Insurance Decisions
There are some complicated and often overlooked questions that should be answered before buying a life insurance policy.
- Do you actually need life insurance?
The most basic function of life insurance boils down to one question. When you’re gone, how much income will your survivors need right away and every year after your death? Survivors are all the people in your life that depend on you and your income. When you are gone, along with your income, how will the bills get paid?
- What type of life insurance you need?.
It really depends on your needs and your understanding of the several different types of insurance policies. Once you understand the different policy types it’s easier for you to make that decision. The two most common types of life insurance policies are “Term” and “Permanent”.
- Term Life Insurance is often the lowest cost to you and is coverage for a fixed period of time i.e. temporary. For example, a 10 year term insurance policy would pay a death benefit if death occurred within the 10 years of the policy.
- Permanent Life Insurance refers to policy types such as: Whole Life, Fixed Universal, Indexed Universal and Variable Universal. Any “Permanent” policy is more costly than “Term” insurance (at least in the beginning), but as long as the premiums are paid the death benefit will be paid at any point when death occurs. Additionally, permanent insurance offers potential for cash value accumulation tax-deferred.
- How much life insurance do you need?
This comes back to the question in our first step, if you’re gone, how much income will your survivors need every year? The table below shows a breakout of the amount of life insurance needed vs. the annual income needed. For example, if your family depended on $100,000 of income per year, you would need about $2 million in life insurance death benefit.
* Income figure assumes generating 5% interest on the life insurance lump sum.