Written by: Owen Chambers
Do I need life insurance? This is a question we often get asked. Life insurance can be intimidating to approach. Once you’re past the initial existential speed bump of accepting your own mortality, there are many companies offering many different varieties of products. In any industry with so many options, it’s difficult navigating the playing field to find the right option for you. Before starting that process, however, you need to confirm whether life insurance in general is right for you at this stage. In an effort to cut through the advertising and confusion, here are four straightforward reasons you might need life insurance.
This is the reason for life insurance that most people are thinking of as they approach the topic. For those of us with loved ones that rely on our financial support, life insurance is one of the best ways to ensure that, even when we’re no longer around, those loved ones are well provided for.
Of course, children are the first thought for most folks on this front, but a spouse with whom you hold a joint debt or a parent who will rely on your support during retirement is equally vulnerable.
Many employers offer group term life insurance, so it can be easy to fall into a trap of assuming that what you have through your job is adequate. While group coverage specifics vary by employer, the amount of coverage they offer is often insufficient for protection purposes.
A basic group term life insurance benefit will frequently range from one times to three times your annual income, which for a primary income earner in a household with young kids will be a far cry from what’s needed to support a comfortable lifestyle, college educations, and a start to retirement for a surviving spouse in the event of a premature passing.
While some employers also offer additional voluntary group life insurance to help cover additional amounts, those policies are frequently not the best choice for young, healthy applicants.
The voluntary life insurance policies through work are usually not portable (they won’t go with you if you change employers), and when they are the premiums often change to be more expensive than they were when you were an employee. Premiums for active employees are typically age-banded, meaning they become more expensive as you get older. Private policies can be acquired on a level-premium basis, meaning that the premium you pay doesn’t change over time.
If you have some group coverage already, it’s reasonable to take it into account while also securing an additional private policy as a complement. It’s totally fine to have multiple life insurance policies as long as you make the companies you apply with aware of what you already have in place.
Generally, for protection purposes term life insurance is the most cost-efficient solution, as well as the easiest to understand. If you’re confident that your need for protection is temporary, term life insurance coverage is the most sensible variety to begin with.
For those who know their need is temporary but aren’t sure just how long they’ll have that need, stacking/laddering multiple policies can be a helpful strategy.
A classic example of this situation would be parents of a newborn. If you secure a 20-year term policy, you’re betting that your 20-year old child will be self-sufficient, or that your wealth accumulation in the next 20 years will be enough to provide for them – a big gamble for a child who will likely still be in college (as well as an assumption that they will be the last child in the family. Not to mention your surviving spouse.).
That said, 30-year coverage is substantially more expensive than a 20-year policy, so securing the full benefit on a 30-year term length can be unattractive.
The solution? Purchase multiple policies of different term lengths that add to the total benefit you need during the most vulnerable period, but create more flexibility on the back end of your term as things come together.
If you need $2 million of total coverage, you can secure $1.5 million of 20-year term and $500,000 of 30-year term, for instance. The larger 20-year policy will be relatively inexpensive and cover your family during the most vulnerable period. The smaller 30-year policy ensures that your family won’t be without protection while wrapping up their education, paying off a mortgage, or getting their retirement plan on-track.
2. Business Loans (Assignment of Collateral)
If you intend to take a business loan in excess of $50,000, you can expect that the lender will require you to carry life insurance with the lender as the beneficiary in the amount of your loan. The short story is that no one at the bank knows how to run your business; if you’re no longer around, they would simply like their money back. This concept is known as assignment of collateral.
While this need won’t impact everyone, especially those who intend to remain employees of a company, for those who would like to start/expand/buy into a business, this can be a major sticking point in their plans. An advisor can help you identify a life insurance policy that will give you the coverage you need on a cost-efficient basis and help you get back to your business.
Generally, term life insurance is an appropriate solution in this area as we can align the length of the policy’s term with the period for which your loan will be outstanding. The shorter the length of a term, the lower the cost of a policy, so structuring this thoughtfully is a great way to save money.
There are other business reasons for life insurance, such as funding a buyout of shares should an owner pass away, or even for funding a non-qualified deferred compensation plan. However, those subjects are an entire blog post in themselves.
3. Life Insurance as an Accumulation Vehicle
Life insurance can be used as a supplementary part of a savings plan. This strategy has received a lot of negative press in recent years and is certainly not for everyone, but for households in the right overall financial position it can be a tax-favorable element of the overall strategy.
For this purpose, you must use a variety of permanent life insurance as opposed to a term policy, because permanent life insurance contracts include the ‘cash value’ component that represents growing worth of the policy.
Whole life insurance is one of the best-known varieties of permanent coverage, but other types such as variable, universal, and indexed universal are also options worth considering. The crediting methods (ways in which these policies grow in value) differ significantly, so it’s important to understand what company/investment the growth of your policy depends on to appropriately determine how this fits in your overall strategy.
Generally, I look for my clients to be meeting the following conditions before seriously discussing life insurance as an element of their savings plan:
- Be taking full advantage of tax-favored ‘pure’ investment vehicles (e.g. 401(k)/403(b) plans, Roth IRAs, etc.).
- Be saving on an ongoing basis into a taxable brokerage account.
- Have substantial excess cash flow and a high degree of confidence that margin will not decrease for the next 10+ years.
- Be confident they could describe the basic mechanics of the policy to a high-school senior – if you don’t understand it, that can be a reason to avoid it!
Once those conditions are met, this strategy becomes worth exploring. When structured correctly, your life insurance policy can exhibit similar tax characteristics as a Roth IRA, primarily access to your cash value in later years without having to pay tax on it*.
Folks using this strategy who also have a temporary protection need (like young children) will typically want to carry multiple life insurance policies – at least one dedicated to protecting their family with low-cost term insurance, alongside the more sophisticated one used to accumulate wealth over time.
4. Future Planning
Life insurance, like many products, is the easiest and least expensive to secure when applied for while young and healthy. Every year older you become, the price of coverage typically increases, and even a minor change in health can make life insurance coverage dramatically more expensive, or potentially impossible to secure.
For that reason, individuals who feel none of the needs above describe them yet, but believe that one or more will apply in the future (like starting a family), may be well served to look into coverage sooner rather than later.
By applying for life insurance while young and healthy, you can lock in favorable rates to be carried forward that won’t change as you become older, or even as you become less healthy over time.
While it’s never fun to pay for a policy which protects a need that hasn’t completely manifested just yet, for many it’s worth it to have the peace of mind that comes with knowing that not only will you have a policy that protects what you care about as your world changes, but that you have it on fair and favorable terms as well.
Can You Have More Than One Life Insurance Policy?
It is very possible that you have multiple needs or reasons to get life insurance. Most people who have a spouse and children need life insurance for the protection reason. But maybe you’re also a business owner in a partnership and need a buy-sell life insurance policy.
In addition to the buy-sell, you also have a business loan for which the bank required you to purchase a life insurance policy for collateral of assignment in case you pass away with an outstanding loan balance.
If you earn a nice income, live in a state with high state income taxes, and are looking for other vehicles for tax-deferred accumulation in addition to your 401k and Backdoor Roth IRA (possibly even a cash balance plan too), you might consider life insurance as a supplemental cash accumulation vehicle.
As mentioned in an earlier example, it is absolutely OK, even common, for people to have multiple life insurance policies. The policies can even be through different companies!
Is Life Insurance Worth It?
Life insurance serves a great purpose for many people. Whether you need it for family protection, business reasons, or anything else, it’s a great tool to provide an influx of cash for your beneficiary should you pass away.
If you find yourself asking the question, “Do I need life insurance?” there is a good chance one of the above reasons may apply to you.
Hopefully this has shed some light on why life insurance is such a common product – of the needs listed above, nearly all of us will be subject to one or more at some point in our lives. If this describes you now, we are happy to talk with you about what type of coverage best aligns with your needs and how to go about securing it.
Related Blog Posts:
- How Much Life Insurance Do I Need?
- Term vs. Whole Life Insurance
- Life Insurance Beneficiary Rules
- Reasons to Get Life Insurance
- Financial Planning for Dentists