Should you purchase term or permanent life insurance? This is one of the questions families answer when buying life insurance. Often, however, it’s not the first or second question on the long list of questions to answer during the process. The first two questions generally are… Do I need to purchase life insurance at all and, if so, how much do I need? Let’s explore…
Do I really need life insurance?
Yes, parents generally really need life insurance. If you bring home an income, or otherwise support a family via your parenting efforts, it is your responsibility and obligation to provide for your family in the unfortunate event of your untimely passing. In most cases, the income, or the effort, cannot be readily replaced. If it ceases, for any reason, it will mean a reduced standard of living for those who remain.
In rare cases the surviving spouse is able to step in to either continue a business or controls other means to increase their income, or efforts. At the very least, an amount of life insurance to support a transition period is generally prudent and should be addressed. While children may greatly appreciate resourcefulness on the part of the surviving spouse, they have no control over any outcomes. They deserve the additional security of intelligent life insurance decisions and actions made during your lifetime.
Since parents obviously need life insurance, the next question is, how much?
That is a harder question to answer. There are rules of thumb. For example, purchase a death benefit equal to ten times your income. Beyond basic rules of thumb, better estimates generally involve some consideration of current assets, liabilities, expenses and years to cover. As soon as these considerations present themselves, our next question quickly blocks the path to answering this one…
Should I purchase term or permanent life insurance?
Permanent life insurance is purchased with the intention to provide a certain sum of money at death, no matter when death occurs. On the other hand, term insurance provides a certain sum of money if death occurs within a certain limited span of time. With those definitions alone, one might purchase permanent insurance.
It is not until the difference in premium amounts between permanent insurance and term insurance is discovered that the full tradeoff is understood. Life insurance companies never give away the extra length of time a permanent life insurance plan is designed to cover, when the likelihood of death, and a payout, dramatically increases. With this financial reality in the mix, we must dig deeper.
First, consider, insurance companies make a profit selling insurance and investing premium payments. Each time insurance is purchased, insurance company profits go up and potential family wealth goes down. When, in return for this fundamental reality, a potentially devastating loss is managed, it’s a wise play for the family. All other times, buying insurance is a form of wasted wealth. Families should only use insurance to cover risks that they would find financially draining to cover on their own.
Specific to life insurance, the most notable debilitating risk to cover is the loss of income and efforts upon the death of a parent or spouse. Since income is generated, and the most important parental efforts devoted toward dependents occur, during working years, this is the period to cover. The insurance product best suited to cover a span of working years is a term insurance policy. It is true, and even preferred, if you like living, that purchasing term insurance could mean paying premiums for decades and never receiving a lump sum payout. Yet, it must be appreciated that the insurance company is on the hook to provide a payout if life ends up short in years. To repeat, term life insurance covers the time period of greatest risk to a devastating financial loss for the family. This is the period of time when the family is dependent on income and efforts, and not assets, to support their standard of living.
With this more thorough understanding of the specific risk that life insurance must cover, we can again assess the amount of insurance to purchase. The question now improves to, how much insurance is needed to cover the loss of a parent’s or spouse’s contributions to their family? That is not a terribly easy question to answer. Therefore, families generally end up with rules of thumb and slightly more sophisticated analysis. Alternatively, FinancialFamilies, as a fiduciary, uses the retirement projections we carefully build with each family as the basis for conversation, to include discussion of underlying assumptions, goals, assets, liabilities, expenses, income adjustments and children’s needs. In short, your family needs an amount of insurance unique to your family.
Remember, FinancialFamilies does not sell insurance. Our financial planning goal is to help your family reach your financial planning goals, not to convince you to buy an insurance company’s favorite commissioned products. The straight answer, in this case, is that rules of thumb and slightly more enlightening analysis can fall short of an effective answer to how much life insurance to purchase. However, without diligent fiduciary review, insurance companies are always more than happy to tell you how much insurance to buy!
This is the tip of the iceberg. There are many other questions to answer when buying life insurance, including… What precise length of time should term insurance cover and should the coverage be reduced as retirement approaches? Is employer-provided life insurance good enough to cover the risk my family faces? Which insurance companies offer the best life insurance solutions? How much should we expect to pay for life insurance? What is the best way to name beneficiaries? How can I help my family manage the lump sum they will receive in my absence? Those questions, and others, must be left for another day… We’re always happy to help you bring success home, for the duration of your own life and for those that dearly depend on you!