Life Insurance 101: How much, what kind, how long?
Thursday, 29 October 2015
Life insurance can become confusing when you consider all the types offered: term, whole life, variable life, universal life.
But you can simplify the issue by keeping in mind the primary purpose of life insurance: ensuring your family has backup funds in case you aren't around to support them.
Term vs. non-term life insurance
Imagine Joe, a 35-year-old breadwinner, has $150 to spend each month on life insurance. Should he spend the full $150 per month to buy whole life insurance or should he buy a less expensive term life plan for a set period of time, say 20 years, and invest the difference? Let's take a look.
Term life insurance is fairly straightforward: Joe pays a certain amount for a guaranteed payment should he die within a defined period of years, or term – 10 years, 20 years, 30 years, etc.
Just as mortgages are fixed rate or adjustable rate, there are two different ways of paying term life insurance:
- Annual renewable term: Joe renews the policy each year, but the rate he pays may vary. Similar to an adjustable rate mortgage, the premium Joe pays for annual renewable term insurance may start at a lower cost and increase as he gets older.
- Level premium term: The level premium term cost Joe pays will be the same set amount each year.
- Which is better? It depends on Joe's situation. If his career is just starting out and funds are tight, the annual renewable option might be a better choice. If he'd like to count on a predictable cost each year, he should pick the level premium.
Non-term insurance products are also known as whole life, meaning that these products are intended to last Joe's entire life, not just a fixed number of years. Several insurance product types fall under the umbrella of non-term insurance. The types are:
- Universal life: Some of the premium Joe pays goes toward insurance; some of it goes toward a safe but modestly growing investment.
- Variable life: Most of the premium goes toward the investment. The risk here is that if the investment returns aren't adequate, Joe will have less than full insurance coverage. Variable universal life: This is a mix of the two above, with Joe having some control over the investment. (Please note that both variable life insurance products and variable universal life insurance products are considered securities products, not solely insurance products.)
- Variable universal life: This is a mix of the two above, with Joe having some control over the investment.
(Please note that both variable life insurance products and variable universal life insurance products are considered securities products, not solely insurance products.)
Choosing the right life insurance for you
Whether your dependents are young children, adult children with special needs, or aging parents, life insurance is there to protect those left behind and assure a certain standard of living if you are no longer around to provide for them. This means you need to take a look at your unique situation and choose the policy that makes the most sense for you.
For example, if you have children, you might pick a term that covers your family until they are out of college (or just out of the house). However, there may be special circumstances — such as a special needs child or a spouse or partner who is unable to work — which make a longer term life insurance necessary. If this is your situation, one of the whole life policies might make more sense.
How much life insurance do you need for "Peace of Mind?"
Many people have some savings in the form of retirement accounts or social security, but that may not be enough to cover the loss of a primary financial provider, especially if they have young children. Life insurance can help ensure that families have adequate resources in such a situation.
So how much money would those depending on you financially need each year without your support and how long they will need it? Well, that depends. Consider consulting with a financial consultant before locking into any plan. But here are a few key questions to get you thinking in the right direction: Should you die prematurely, what are the immediate obligations for your family and/or dependents (e.g. private school tuition, home health aid for ailing parents)? Next ask, "How long will they need my support?"
Several websites, such as www.lifehappens.org, provide life insurance calculators to help you figure out what amount of life insurance you may need. As a rule of thumb, consider erring on the high side. You may be able to provide your family or dependents significantly more peace of mind with a minimal increase in your term payment.
But ultimately, there is no one right answer, just the answer that is right for you and your family. And with something as important as life insurance, consulting a financial professional, who can help you evaluate the options within the context of your personal goals and financial situation, is often useful.
The content provided is for informational purposes only. Neither BBVA USA, nor any of its affiliates, is providing legal, tax, or investment advice. You should consult your legal, tax, or financial consultant about your personal situation. Opinions expressed are those of the author(s) and do not necessarily represent the opinions of BBVA USA or any of its affiliates.
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