Life insurance should be an important component of your financial planning. If you have a young family, it could actually be the most important element of their security. Surprisingly though a lot of people do not have affordable life insurance. Among those who already have life insurance, a vast majority does not have enough coverage. Could you be one of them?
What kind of insurance is best?
Life insurance policies come in two basic variants – whole life and term life insurance. Whole life insurance offers death benefits plus cash value, on account of which premiums are higher. On the other hand term insurance is affordable because it only concentrates on death benefits for which you pay cheaper premiums. When you are young with a lifetime of loans, expenses and mortgage payments to be paid, your kids education and upbringing to look after, you must consider the more affordable term life insurance. Since a term life policy can help you focus on just the death benefits, it makes sense to understand it better, and work out the best coverage amount possible.
What kind of expenses and financial needs should a term life policy cover?
On the event of your death, the death benefit of your term life insurance policy should be able to have your family pay off your funeral expenses and invest the rest so that they can lead a comfortable life much like the one you provide for them now.
- Funeral expenses can work out to be as high as $5,000-$12,000 currently, so that’s why you will need to factor that in to your life insurance planning
- Next, your death benefit should replace your current income, so that your family can carry on with life without having to make major lifestyle changes. Remember to take into account inflation and rising costs.
- Thirdly, factor in your debts – unpaid mortgage, credit cards and loans could eat into the death benefit amount, leaving your family with very little to take care of other expenses.
- If you were to die, your family would surely have additional expenses to replace the services you used to take care of yourself. If you handle the accounts on your own, or take care of the plumbing yourself, your family may need to hire the services of an accountant, or a plumber. If your spouse is currently a stay at home parent, your family may need the services of a nanny in case he or she decides to start working to supplement their income. It’s the little details that will help you work out your family’s expense requirements better.
- If your kids are young, a part of the death benefit will have to be invested to pay for their college education.
- Consider any hidden income that you may be currently earning, but which would be lost at death. Examples are your perks, your employer’s contributions to your 401(k) plan, health insurance and your retirement fund contributions. Too many people overlook factoring this into their calculations while in actuality they could easily add up to $10,000-$12,000.
How to calculate the coverage amount
There are conflicting views on how to arrive at the perfect coverage amount for your life. Here’s an alarming statistic. The average American has about $170,000 in life insurance coverage. That seems like a lot, but it is only about four times of the average annual income in the U.S. So it’s going to tide your family over for four years, but remember that you’re going to be dead a lot longer than four years. So how do you calculate the ideal coverage amount?
The rule of thumb in the insurance industry says that your coverage should be 10 to 20 times your annual income. However, like we discussed earlier, annual income is not the only factor that should be considered when determining your needs. How much term life insurance you need is a highly individual figure. But if you know exactly what your death benefits should help pay for, then you definitely won’t make the mistake of under-insuring yourself. So the long and short of the ‘how much is enough’ dilemma is that the death benefit you provide your family should be more than your net worth. Use the help of online Life Insurance Tools such as a Life Insurance Needs Calculator to help you arrive at an accurate coverage for your personal situation. Then you can apply for term life insurance quotes.
How often should your policy be reviewed?
If you already own a term insurance policy, that’s not enough reason to think that you have enough death benefit. If you have failed to consider the expenses and the loss of income sources that may follow your death, you will need to review your policy.
Even if you have taken everything into consideration, experts recommend that you review your policy whenever there is a life changing event such as the arrival of a baby, taking in an additional family member, changing jobs, looking after ailing parents, or the loss of a spouse. These events will increase your expenditure.
In times of recession the value your investments drastically dip, while your life insurance benefits remain the same. If you were to die in the next two years, your investments would have accrued a lower income than expected due to the present economic crunch. Have you factored this into your life insurance plan? You may need to review your term policy especially during economic downturns.
The best way to review your term insurance policy or work out the death benefits on a fresh term life policy is to consult with an unbiased insurance advisor, preferably one who represents a large number of life insurance companies. The advisor will ask you in-depth questions on your finances and help you arrive at term life quotes that are just right for your family’s needs.
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