For better or for worse, there is a lot of information out there about life insurance.
A quick Google search on life insurance pulls in 2 billion results. And a quick search on Amazon shows more than 3,000 books listed on the topic of life insurance.
The abundance of information and opinions on the matter can be confusing and overwhelming.
But is life insurance really as complicated as it seems? Sure, there are some advanced planning strategies involving obscure provisions in the tax code related to life insurance that can only be implemented by a well-trained professional.
For the most part, however, basic term life insurance can be and should be relatively straightforward to understand. It should also always be incorporated into any holistic financial plan.
Let’s start with the fundamentals by answering a few important questions that you might have about life insurance.
What exactly is life insurance?
Before we get into the details of life insurance, let’s first get clear on what exactly it is.
A life insurance policy is essentially a contract between a customer and an insurer that guarantees the payment of a death benefit to the named beneficiaries if the customer dies during the term of the policy. In exchange, the customer pays premiums for that coverage during the term of the policy.
The purpose of life insurance is primarily to provide financial protection. This financial protection is for the people who depend on the policyholder for their financial well-being if the unthinkable happens to the policyholder.
Let’s consider this example below:
Alex has a husband and two young kids that depend on her income as an attorney. She can go to a life insurance provider and apply for a policy. After determining her needs, she applies for a life insurance policy with a $1,000,000 death benefit. The insurance company asks for a premium payment of let’s say $50 per month to keep the policy active for the 20-year term. Several years later, Alex is involved in a fatal car accident. The insurance provider then pays out the $1,000,000 to Alex’s husband. He can use the funds to pay for Alex’s medical bills and funeral, pay off their home and a few other debts, create a college fund for his kids, and go back to school to start a new career to become the primary breadwinner in the family.
If Alex did not apply for a life insurance policy and get one, things would look very different. Her husband would be responsible for paying for medical bills, funeral expenses, their home, and more without having any support through a death benefit.
Unfortunately, this often results in people taking on significant debt and even filing for bankruptcy.
Do I need life insurance?
There are very few families that couldn’t benefit from some form of life insurance, at very least through the age of retirement.
It might be easier to describe the rare situations where life insurance wouldn’t be needed than to outline all the cases where it would be needed. As a rule of thumb, unless you are quite wealthy or have no one depending on you financially, you should consider life insurance.
One of the easiest ways to determine if you need life insurance or if you have enough coverage is by creating your financial plan. Savology will analyze your circumstances and provide expert analysis on the amount of coverage you need to properly protect your family.
How much life insurance do I need?
If you’ve found yourself asking this question, you’re not alone.
There might not be one absolute answer to this question as it varies for every person and every situation. However, using a logical and formulaic process to come to an informed and specific conclusion for your circumstance can help you cover your bases and rest easy.
Savology’s life insurance methodology
Savology recommends a methodology that primarily takes into consideration your income, net debts, and children. Below is the methodology that Savology recommends and you can use to calculate your life insurance needs if you are responsible for all of the household income:
- Start with half of your household annual income, to handle costs such as funeral and probate
- + 3x your own current annual income, if married
- + $250,000 per child under age 21, pro-rated by age*
- + Total debts and liabilities (auto loans, mortgages, credit cards, student loans, etc.)
- – Liquid Assets (non-retirement investments, emergency funds, bank accounts, etc.)
- Then, for ease of use, round this total to the nearest $50,000.
*This formula does vary to a small degree based on the percentage of household income that you are personally responsible for. If you are responsible for 75% or more of the household income, use the formula above. If not, but you are responsible for 50% or more of the household income, you can reduce the base amount needed per child to $200,000. If not, but you are responsible for 25% or more of the household income, you can reduce the base amount needed per child to $150,000. And if you are responsible for less than 25% of the household income, you can reduce the base amount needed per child to $100,000.
The exact reasoning for all of this will be provided in a separate, more detailed article on this topic. The calculation isn’t necessarily complicated, but it can be hard to gather and group all the information needed. Savology does this work for you when you create a free financial plan.
An example on calculating the coverage amount
Here is the example of Alex again. This time with the above calculation in action:
Alex is married and has two kids, ages 10 and 5. She makes $50,000 per year out of the household income of $80,000. They have a house worth $500,000 which has $450,000 left on the mortgage, but no other debts. They have a total of $50,000 in liquid investments and cash.
- Start with $40,000 to cover funeral and probate
- + $150,000 for income transition
- + $104,761 to raise the 10-year-old and $152,380 to raise the 5-year-old (pro-rated by age to $200,000 because of her income share)
- + $450,000 for mortgage
- – $50,000 liquid assets
- = $847,141
- = $850,000 rounded to nearest $50,000
Then, to determine your coverage gap, you subtract your life insurance need from the amount of coverage you already have. That tells you how much additional coverage that you can get to close your gap and mitigate additional risks.
In the example, Alex didn’t have any life insurance, so the full $850,000 was considered her life insurance coverage gap. In twenty years, if she has acquired enough liquid assets to cover the debts and income replacement, she may choose to forego life insurance completely.
What kind of life insurance is right for my family?
Generally speaking, term life insurance is the way to go. Term life insurance is the easiest type of life insurance to secure, easiest to understand, easiest to work with, and it is the most affordable.
As your financial situation becomes more complex, you may consider other life insurance types such as permanent life insurance, including indexed universal life or whole life.
You can also explore adding “riders” – added provisions in a policy to provide additional benefits at an additional cost – such as accidental death, disability, waiver of premium, child term, long-term care, or return of premium.
You probably should not, however, consider those without the help and consultation of a knowledgeable and trustworthy professional that is genuinely interested in your needs, not just the sales commissions they can get by selling you into a more expensive product.
How can I get life insurance?
Technology makes it easier and easier to obtain life insurance every year.
The traditional process of getting term life insurance required you to go out and find an insurance agent, talk to your agent about coverage, fill out a lengthy paper application, mail it in, get a medical exam, wait for the results, get a quote, and then decide whether or not to bind the coverage.
Nowadays, you can get life insurance quotes online, fast and free. In some cases, you can apply online, bind the coverage right away, and forego a medical exam!
Savology has partnered with and highly recommends three reputable providers to simplify the process for you to get life insurance: Ladder, Policygenius, and Coverpath by MassMutual. You can get a free quote in minutes from these providers to compare quotes and determine which policy is best for your plan.
For more information on these providers, you can read our reviews on each one of them below:
Alternatively, you can also get a quote instantly in just a few seconds below:
Moving forward with life insurance
When used correctly, life insurance can provide peace of mind for you and can help mitigate financial risks for those that depend on you. Now that you have fundamental answers to many of the key life insurance questions, you can determine how much life insurance you need and how to get it so that you can benefit from that additional peace of mind and protection that come with proper coverage.
This article is provided by and expresses the opinions of Savology to help users make informed financial decisions. Many of the featured products on this site connect to our affiliate partners. Partners may provide compensation to Savology for referrals, which in turn allows Savology to provide the free financial planning platform. Compensation does not influence the product evaluations or recommendations.
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