Life insurance can be an essential element of protecting and providing for loved ones in the event of a death. If anyone is financially dependent upon you, such as a spouse or children, it’s important to consider their financial wellbeing in the event of your premature death. While it might be apparent that life insurance is a good idea, it is often harder to ascertain how much insurance is needed. In this article we discuss the main points you should consider when determining and selecting appropriate coverage.
How Much Life Insurance Do I Need?
There’s a common belief that $1 million of life insurance is universally adequate. While this amount might be sufficient for some, it can be woefully inadequate for others, particularly for families with children. Consider the following when determining how much life insurance you need to replace your earnings and cover your loved one’s anticipated needs:
- The amount of lost earnings.
- The level of projected financial needs (existing or perhaps new).
- The duration of financial needs.
- The amount of replacement earnings (i.e., Social Security survivor benefits).
- The level of existing assets available to meet financial needs.
The loss of your earnings could have a material effect on your household, regardless of whether you are the breadwinner. If your household is using your income to support both current expenses and savings (for retirement, college savings or other), it is important to replace the income void. Looking at your level of earnings and net take-home pay to the household is a useful starting point in determining insurance funding levels.
Projected Financial Needs and Their Duration
In addition to replacing your lost earnings, it is important to consider new and future expenses and scenarios that might exceed those earnings, such as:
- Spousal Earnings: Family objectives and circumstances can change upon the death of a loved one. If you are married, you should consider if your spouse would start or continue to work, and the level of their anticipated earnings. His or her future salary might continue at current levels, increase to replace your earnings, or possibly decline to address additional parenting obligations or for other reasons.
- Child Needs: If you have children, the cost of their needs is an important element of your funding. The cost of raising a child totals hundreds of thousands of dollars as a national average. Furthermore, you should consider potential costs if the surviving parent will need additional childcare assistance while working or in general.
- Retirement Savings: You might wish to explore your spouse’s long-term financial wellbeing toward the objective of funding his or her retirement objectives. This could include the loss of your projected retirement savings as well as the loss of retirement income, such as lower Social Security benefits and/or pension income.
- College Funding: If college funding for your children is an important objective, the cost of projected college expenses (less current college savings) should be included in your insurance coverage needs.
- Health Insurance Replacement: Your survivors might have higher health care expenses if health care is covered by your employer benefits. The cost of possible replacement coverage through work or private funding should be factored into calculations.
- Ongoing Needs: Sometimes financial needs persist for long durations such as planning for a disabled child. Any such circumstances should be factored into your funding analysis.
The Offset of Replacement Income and Existing Savings
Finally, the amount of funds needed in the event of your death should be adjusted or offset by the amount of current savings as well as potential replacement income such as temporary Social Security survivor benefits.
How to Fund Insurance Needs
There are a variety of insurance products to fund your calculated insurance needs. These predominantly include term insurance, variable universal life (VUL) and whole life policies. We explore these below.
Employer Group Insurance
Many employers offer life insurance benefits such as a stated amount or one times your salary. Employer plans also frequently include the option of buying additional group insurance coverage. These life insurance funding sources can create a base in funding your insurance coverage and could be ideal if coverage excludes the need for insurance underwriting (evaluating your health relative to insurance eligibility). However, there are two key drawbacks associated with group coverage. First, your coverage often terminates upon your separation of employment. This could create a future insurance funding gap. Second, the costs of supplemental group coverage sometimes exceed the cost of alternate funding options. Privately-owned insurance policies (discussed below) should be part of your insurance funding considerations.
We frequently recommend term insurance. It is the most affordable type of life insurance and often most appropriately funds temporary insurance needs such as raising your children. As the name states, term insurance covers a period of time, versus extending during your lifetime. Coverage is offered in increments of five or ten year periods. We often suggest laddering insurance relative to projected needs at varying timeframes. For example, your life insurance needs are greatest when your kids are young and progressively decline as they age. Likewise, your replacement income for a spouse or other family members declines as you age and accumulate savings for their future benefit. The lower cost of term insurance helps you to achieve your lifetime goals in the likely chance that you survive the period of time when life insurance needs are greatest.
Variable Universal Life Insurance
Variable universal life (VUL) insurance policies combine insurance coverage and asset accumulation. This is achieved by allocating a portion of your premiums paid to an account within the policy that grows by investment performance. Not all of your premiums are allocated toward investment as the premiums also need to cover the cost of life insurance and embedded policy costs. We seldom recommend VUL policies due to the level of inherent costs. Premiums for such policies are higher than term insurance, and the internal cost structures typically range between 2% to 3%. These high fee structures infringe upon investment performance, often making such policies an inferior savings element toward your retirement objectives.
Whole Life Insurance
Whole life policies extend for the duration of your life, although they might include a maximum age of coverage into your 90s or 100s. The premiums for these policies are much higher than those of term and VUL policies. These policies are typically used to fund long-term coverage needs, such as for a disabled family member, or to replenish projected estate tax wealth dilution.
Finally, when you obtain life insurance policies, you must name the beneficiary(ies) who will receive the policy benefits in the event of your death. Sometimes it is appropriate to name individuals to receive policy benefits directly, such as for a spouse or adult child. However, there are instances where a Trust should be named such as for young children or the protection of adult beneficiaries. We explore these and other estate planning considerations in our Essential Estate Planning Documents and Estate Planning for the Benefit of Children (of All Ages) articles. SageVest Wealth Management is a fee-only financial advisory firm. This means that we do not sell life insurance, nor do we receive any fees or commissions for insurance policies obtained. Our fee-only structure gives clients the assurance that any recommended insurance suggestions are based upon your true needs versus our financial incentives. Please contact us if you would like to explore your insurance funding coverage or other financial considerations.