When you buy life insurance, you enter a contract with an insurance company that promises to provide your beneficiaries with a certain amount of money upon your death. In return, you make periodic payments, called premiums. The premium amount is based on factors such as your age, gender, medical history, and the dollar amount of life insurance you purchase.
In the event of your passing, life insurance provides money directly to your beneficiaries. They can use the money for:
- Making up for your lost income
- Funding a child’s education
- Paying off household debt
- Paying for your funeral and other related expenses
Certain types of life insurance may provide benefits for you and your family while you’re still living. For example, permanent life insurance offers a cash value component, which can be used during your lifetime.
There are two main categories of life insurance
Term life insurance offers protection for your loved ones for a specified time period—usually from one to 20 years. If you stop paying premiums, the insurance stops. Term policies pay benefits if you die during the period covered by the policy; but they do not build cash value.
Permanent life insurance policies do not expire; they are intended to protect your loved ones permanently, if you pay your premiums. Some of these policies accumulate cash value. Learn more about the difference between term life insurance and whole life insurance.
How much life insurance do you need?
Your goal should be to develop a life insurance plan (through one or more policies) that, following your death, compensates for the loss of your economic contribution. Here are two ways to determine how much life insurance you may need. Work with your financial advisor to figure out the best approach for you:
Replacement income need
This is a well-established method in determining the financial contribution you can expect to make to your family from now until you would retire. It’s more than just replacing your income; it accounts for everything you provide for your family, including:
- Benefits/health insurance
- 401(k) and retirement savings
- Personal services you perform for your family, such as childcare, cooking, home maintenance, etc.
- Less, your personal consumption—annual spending on personal needs, such as food, clothing, entertainment, etc.
Survivor needs analysis
This approach is based on replacing an amount of income needed for your surviving spouse and children to maintain a desired level of income and lifestyle. Your survivors’ needs are then compared to their assets, existing life insurance, and income sources to determine any additional life insurance requirements. An insurance professional or financial advisor can help you determine an accurate figure and choose appropriate coverage.
It’s never too early to start thinking about life insurance and get the financial security you and your family need and deserve.