Introduction

One of the most cringe worthy conversations you can have is about one’s own mortality. No one can breach the subject without at least a little existential pang in the stomach - and it’s usually worse for your loved ones to talk about. However, planning for when you leave - whether it’s unexpected or otherwise -  is essential to “getting one’s finances in order.” Sure, you won’t be around for it but your family and those who have relied on you will. Setting up your loved ones is a big part of your legacy planning and that's where life insurance comes into the discussion. Life Insurance is a way to make sure those who’ve depended on you are able to live comfortably or can continue to support your obligations after you’re gone. Although no one loves to talk about it, it is something we all have to consider.

What is it?

Life Insurance is an arrangement between the insurance company and the policyholder (the insured). This arrangement states that the insurance company will pay an agreed upon amount of benefits, upon the insured’s death, to a named beneficiary or beneficiaries, provided the insurance premiums have been paid and the account is current. The main goal for the insured is the comfort in knowing that an exact amount of benefit will be flowing to the beneficiary when they are no longer there to provide. 

There are two different forms of life insurance - Whole Life and Term Life. Whole life - the more expensive option - works more like an investment, taking specified premiums and investing them. Term life is much more simple (and inexpensive). This type of insurance lasts for a specific period of time. If you pass on within that window, you get the benefit. If not, the term expires and you look for some other insurance. Some Term Life providers will allow you to renew your coverage after a certain expiry date, though at a much higher rate than when you were younger and healthier! Each specific type of insurance is appropriate for very different applications.

Who Needs It?

The most important consideration when one is deciding on life insurance is... why? If you have to ask yourself this question, you probably don’t need it. The fact is, if you have lived a life married to your job and there is no one who has been relying on you through the years, the need to leave a legacy is just not that important. If you are the matriarch or patriarch of a large family of which you have provided for over the years, you may feel a deep desire to leave those in your family a financial legacy. If you have worked your tail off your whole life and managed to amass a sizable legacy on your own, you may find that spending premium on a policy that would simply make your loved ones “more” rich might not be money well spent. Some might have sizable assets but may owe a considerable amount on them. Evaluating how much would be left after paying debt is one key equation to consider.  

Old vs Young

The one constant in the insurance industry is that insurance companies want to insure you. Rarely will an insurance company turn down the opportunity to collect a premium on a person looking to pay them one. The problem is that a person with questionable health and family history might be quoted an astronomically higher premium for the same coverage as a person in their 30s with no health issues. Almost always, once the benefit crosses a specific dollar amount, the insurer will require more complicated health evaluations - usually involving bloodwork and a visit from a nurse. Regardless, the insurance company has complicated equations they use to determine certain probabilities on people in specific age ranges and base their premiums on the expected outcome of those groups. The question is this: is the need for that benefit worth the cost of the premium you will pay for the duration of the term?

Is Life Insurance an Investment?

Life insurance can act like an investment, especially Whole Life insurance. Insurance companies actually love this arrangement because they get to use your premiums - an amount that is much higher than a typical term premium - to invest in the markets. For this, they agree to pay the insured a small amount of interest on your cash value. Some people are completely content with this arrangement. These payments are guaranteed and for some, that is their most important need. For the vast majority of investors, however,  this is not the ideal way to build out an investment portfolio. A diversified portfolio in a balanced index fund will always outperform this type of investment over time - to a large degree.  A portion of one's entire investment portfolio may be suitable for this type of investment but the core of one’s investment portfolio should be allocated in other asset classes outside of a Whole Life insurance policy.

How much do you need?

For the most part, choosing a life insurance policy is all about figuring out how much money your dependents will need. Choosing that amount depends on a couple of factors.

• Your debt.
  You don’t want to leave a mountain of debt piled on your loved ones after you depart. Understanding how debilitating debt can be is critically important when figuring out how much life insurance to obtain. 

• Income replacement.
  After your debts have been covered, the second most important part of the equation is replacing the income you earned - especially if you have been the sole earner. This means that if you have been earning $100,000 per year and you die at 50 - assuming that you have a nest egg started already - you will need to have a policy that will cover the rest of your earning years, and then some. Inflation (which is about 2.5% a year) needs to be accounted for as well. Ideally, your inheritance would be invested so that your legacy would grow. Under this scenario, if you were to set a policy that would replace your income, a policy of at least 1.5 million dollars would be a good start. Ultimately, your insurance agent can provide that guidance. 

• The final calculation.
  Most insurance agents will start with advising that an appropriate amount of insurance would be 6 to 10 times the amount of annual salary plus the value of outstanding debts. The best way however would be to multiply your annual salary by the number of years left until retirement. In the previous example, if a 50 year-old man currently makes $100,000 a year, the man will need $1.5 million (15 years x $100,000) in life insurance to start. If there exists another $500,000 in outstanding debt (cars, mortgage etc), that $500,000 should be added to the face value of the policy to bring the number to $2 million dollars of insurance. 
  
  

The Bottom Line

If you need life insurance, it is important to know how much and what kind you need. Although generally, renewable term insurance is sufficient for most people, you have to evaluate your own situation. If you choose to buy insurance through an agent, decide on what you will need beforehand to avoid getting stuck with inadequate coverage or expensive coverage you don't need. As with investing, educating yourself is essential to making the right choice.

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