Life insurance is something you buy and hope you'll never use.
But if you have anyone in your life who depends on your income, you might want to give it some thought. The big questions to answer: Do you need it? If so, how much should you buy? And what kind should you get?
It shouldn't be confusing. The main thing to remember: Life insurance is designed to replace lost income or pay for special needs your family would have if you weren't around.
If you decide you are a good candidate for life insurance, your next step is to estimate just how much you need. Doing that will also give you a good snapshot of your lifestyle and financial needs, and that will make it easier to select the type of policy you need.
And when you talk to an insurance agent (and you probably want to talk to at least three), if you feel you're being rushed, pressured, guilted into buying more than you need or talked into a product you don't want or understand, walk away. There are tons of carriers and plenty of good agents who will take the time to explain the options, then back off and let you make the decision that's right for you.
Who needs life insurance?Not everyone should get life insurance. "For someone young and single with no dependents, there's really not a need for life insurance," says Owen Malcolm, CFP, vice president and CFO of Sanders Financial Management in Atlanta.
But if you've got a spouse, kids or aging parents who depend on you, life insurance is a good option.
If you're a wage earner, you want to replace your salary, plus provide for any additional needs, such as paying off the mortgage, college tuition or career training for a spouse who may be re-entering the workforce.
Another question to consider: Would your working spouse want to take some time away from the job to be with the kids after a loss? If so, what would that cost?
If you're a stay-at-home parent, look at what it would cost to hire help to perform tasks you routinely do (day care, housekeeping, financial management, cooking, grocery shopping). If you're caring for a family member with special needs, what would it cost to make sure that person is provided for if you die?
Also look at where you are in life. If you're at or near retirement, how would your spouse's income change if you weren't around, or vice versa? If all or most of your pension or retirement savings would be accessible, you might not need life insurance.
Examine your tax situation. Years ago, families carried insurance policies just so they could be sure that estate taxes wouldn't force the sale of homes or assets. But today, with higher thresholds, "very, very few people need insurance to pay an estate tax bill," says Malcolm.
How much is enough?Once you have an idea of what you're replacing, tally it up. How much would your family need per year if you were not around? Then calculate how much it would take, invested conservatively, to generate that amount annually without ever touching the principal. Estimate about 5 percent to 6 percent a year in interest, says Malcolm.
"I wouldn't ever want to put a client in a situation where the withdrawal rate was more than 5 percent, maybe 6 percent over a longer period of time," he says. "Anything over that, there's no guarantee."
Say you also want to pay off the $200,000 that's left on the mortgage and leave $200,000 to put your teenager through Harvard. That means you need to buy a policy with a face value of $1.4 million.
If you want to replace a $50,000 annual income, you'll need a $1 million policy.
You want to replace $50,000 annual income and you're getting a 5 percent return on your investment:
5 percent return on investment
- It will take $1 million to generate $50,000 annually.
- That means you need a $1 million life insurance policy just to cover your current income.