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One of the costliest risks that families face is the
death of a breadwinner (worker). This is especially true if a spouse
and/or children depend upon that person for all or part of their support.
To protect family members against financial disaster, consider the
purchase of life insurance.
There is no simple formula to determine the amount of life insurance you
need. Many factors must be considered, including:
- current assets and current liabilities
- earning power of surviving family members
- other sources of income to the family
- projected expenses and family support
Carry too little insurance and you may not provide a reasonable living for
your family after death. Carry too much and you may not enjoy a reasonable
level of living while you're alive. Many insurance companies have
worksheets to calculate life insurance needs. They total up a family's
economic needs and subtract available resources.
Worksheets generally include a total for lump sum cash needs such as
mortgage liquidation, debt repayment, and final expenses. There are also
calculations for the income needs of children and a surviving spouse.
After the total amount of money needed is calculated, existing insurance
and assets are subtracted to determine the additional amount of insurance
required.
Once you have calculated the amount of coverage that you need, choose an
insurance product that is right for you. There are two basic types of
coverage which, in one form or another, are the basis for virtually all
forms of life insurance. The two basic types are term insurance and
permanent (cash value) insurance.
Term insurance, simply stated, is insurance that provides protection only
for a specific period of time--this period of time is called the term.
Term insurance has no cash value or investment value. Term insurance is
one of the best ways to solve an insurance need having a short or limited
duration (e.g., the years when children are dependents). It generally also
has the lowest up front premium cost.
Term insurance offers a specific amount of protection for a given period
of time. Each time the policy is renewed, the premium increases to reflect
the additional risk as an insured person ages. Some types of term
insurance, called level term, may have premiums which only increase every
five or ten years or stay level for a certain number of years or until a
given age. The longer the time of the guaranteed premium, the higher the
initial premium will be.
Decreasing term was developed for people having an insurance need which
becomes smaller over time. It is most commonly used when there's a
declining degree of financial responsibility, such as a home mortgage.
With decreasing term insurance, the level of protection declines over
time, but the premium remains constant.
Permanent life insurance combines protection for the entire life of the
insured person along with a savings component known as the cash value.
Annual premiums are fixed for the life of the policy and are based on
assumptions about interest and mortality rates. These premiums may be
payable for life or for a limited number of years. Common forms of cash
value life insurance include whole life, variable life, and universal
life. The main difference between these different forms is in the method
of cash value buildup.
Most People Don't Have Enough Life Insurance
An agent selling life insurance may tell you to "buy now" because your
premium (insurance cost) will cost more later. Others argue that if
you don't need insurance now, saving your money and investing it is
better. This may be true. It depends on your ability to save and your
health. Before you decide to put off buying now, consider your chances of
getting an illness or injury later in life that could make you
uninsurable.
Children don't need life insurance unless they are family wage earners.
You, as head of the household, should buy insurance on your life to
protect your children in case of your early death. Again, there is one
exception. If you get support payments for a child and these are important
to your family's income, you may want to buy life insurance for that
child.
Say you've decided you need life insurance. How much is enough? There
is no simple formula that tells you the right amount.
One way often suggested to figure how much life insurance you need is
to use a formula. Some experts suggest buying life insurance equal to five
times your yearly income. Using this formula helps you buy enough
insurance for your family's current money needs. This formula assumes that
there is group life insurance from work for an amount equal to one year's
salary. It also assumes that the person who will get the life insurance
payment is eligible for social security survivor benefits.
If both husband and wife work, buy insurance on both. You need more
insurance on the person with the highest income. For example:
| You earn |
$15,000 |
| Spouse earns |
$20,000 |
Using this rule, buy life insurance
| on your life |
(5 x $15,000) $75,000 |
| on your spouse's life |
(5 x $20,000) $100,000 |
In this example, using the five times annual income rule, you should
buy $25,000 more insurance on your spouse's life than on your life.
Other formulas figure in the income needs and financial goals specific
to your family, such as ages of your children, current income, pensions,
property, veteran's benefits, social security, savings, health of your
spouse and children and amount of money you have to spend on insurance.
Remember, there is no final formula for deciding the amount of life
insurance you need. So be careful! Don't buy it if you don't need it.
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