One of the most common questions we get is, “How much term insurance do I need?"
There is a misconception that all “term” insurance is created equal, so all you must look at is price. This misconception can leave you high and dry as you age and get older. Some term insurance polices are convertible and some are not. Some term policies also have a return of premium guarantee and some allow you to “recapture” the premiums you have put into the policy towards another.
To first identify how much term you need, we need to look and see what you are getting for the money. To do this we must define the different types of term insurance so that you know what you are buying.
1) Basic Term Insurance
This is the term insurance everyone is assuming they get. This insurance will provide a tax-free death benefit, should the insured pass away in the specified term (ex. within the 30 years of a 30 year term policy contract).
This type of term insurance is best used to protect your debt, especially a mortgage or a business loan. This term insurance does not offer any additional benefits to you. Typically, the "basic" term insurance is the cheapest term you can buy.
2) Convertible Term Insurance
This term insurance offers the same protections as above, but you also can convert to a whole life policy in the future without having to prove medical insurability again. This is an important feature.
None of us know what will happen as we get older. We can develop cancer, diabetes, or any other hosts of disqualifying diseases that would eliminate our ability to get insurance in the future. It is important to understand your policy and know the limits so that you can take advantage of the convertible time frame. If you purchase insurance through us, we will keep an eye on this for you as well.
3) Recapture Term Insurance
This is a rare form of term insurance. This insurance is built for people that know they want a whole life policy but can’t quite afford to put money back each month for it. This insurance allows you to put all funds towards a whole life policy down the road. There is usually a time frame in which you must upgrade to take advantage of this perk as well. You will also get to upgrade this type of insurance without having to prove medical insurability again.
4) Return of Premium Insurance
This type of term insurance is the most expensive. In these term insurance policies, a person is guaranteed to get their premiums back if they do not pass away during the specific term. While this insurance sounds very appealing there is a large cost of opportunity that comes with it. This type of insurance has a premium typically 1.5 to 2 times higher than a convertible term policy. This leads to lost opportunities that you could be doing with half of your monthly premiums.
Yes, you do get your money back, but no interest is credited to the funds you let the insurance company hold for you.
Now that we have identified the different term polices, we can now talk about how much of it you need. There are 5 main factors that determine the answer to that question.
1) Are You Married?
If you are married you must think about how to best protect your spouse. If you are married, you must protect them from any amount of debt you may have incurred including mortgage, credit cards, vehicles, and personal loans. When you pass away you spouse will be responsible for these debts. Without your income to help them pay them back, could they handle the new responsibility on their own?
2) Do You have Children?
If you have children the amount of term you need increases a lot. If you are married with children, you must now protect your whole family.
This means costs of living have increased with the additional responsibility. This is where we must remind both husbands and wives about all the responsibilities that will follow your death. Not only will your income drop substantially, but now you will not be able to work as much since you must be at home with the children more often. You will have to be there for them to not only help them through the grieving process, but also be available to run them to school and other activities. This will also drop your income.
Next with children involved comes the wishes we have for them. Do you want your children to go to college? Do you want to help them with their wedding or their first house? All of these scenarios will affect how much term insurance you need.
3) Do You Have Debt?
The amount of debt that you have also determines how much term insurance you need. If you do not have any debt, we can go off 10 years of your income, plus any of the things you want to provide for your children once you are gone. If you have a lot of debt, then you should add that amount of debt to the other factors above.
4) How Much Income Do You/ Will You Have?
It is important to not only look at how much you currently make, but also how much you may earn in the future. This is especially important for young people. If you are earning an intern’s wage now, we must look at what you will be making once you obtain the career you are looking for. A good rule of thumb is 10 years’ worth of your income plus any debt you may have. Remember, when you are young and healthy, you'll qualify for a large amount of death benefit with a small cost attached to the contract-- use this to your advantage!
5) Do You Have Any Retirement Funds?
This may be a surprising factor to consider, but it is important to protect your loved ones from unexpected taxes. Your retirement accounts (401ks, IRAs, etc.) can come with a hefty tax bill once you pass. If you haven't taken the appropriate steps to protect your loved ones, they will be the ones footing the bill. The amount of insurance you'll need to protect your family from these tax implications also depends on the state you live in. Some states will hit your family with estate taxes, inheritance tax, gift tax, and income tax. Usually not all of these taxes will be applied, but that is why it is important to know the laws in your state.
All of these are important factors to consider when deciding how much term insurance you need. Therefore, it is important to talk to a professional that asks these questions. A simple online calculator will not be able to have a conversation with you. It is important to remember you get what you pay for. The cheapest is not always the best for you. You should talk with someone you trust that is a professional, not an order taker looking to make a quick sale. There are a lot of things to consider when looking for the correct protections and you deserve the best service you can get.
For more information or to schedule a free consultation, go to www.lyvfin.com