The Importance of Life Insurance: A Complete Guide
Thinking about not being here tomorrow is a scary thought.
How would your family survive financially?
Whether you work out of the house or are a homemaker, you provide value to your value, and if you’re gone, there will be voids your family must replace.
Life insurance can’t bring the deceased back, but it can help protect the family financially so they can process their grief and not have to worry about finances.
If you haven’t purchased life insurance yet, it’s time to consider it. Here’s why.
What is life insurance, and how does it impact you and your family?
Life insurance is a legal agreement or contract between the insured and the insurance company. Life insurance includes a death benefit or the amount the insurance company will pay upon the insured’s death if it’s for a covered reason and falls within the contracted dates of the policy.
Many people assume they don’t need life insurance if they are single, older, or have grown children who no longer live at home, but there are always reasons to carry life insurance, including the following:
- You are married and are a one-income household
- You are married, and your spouse relies on your income in conjunction with his/her income
- You have young children that depend on you
- Your family could not afford to pay for your funeral
- You own a business with business partners
- You have adult children with special needs that depend on you
As you can see, there are MANY reasons to have life insurance. It’s not just for married couples. You can carry life insurance even if you’re single or an empty-nester.
How Does Life Insurance Work?
Life insurance is a contract you sign with the insurance company. You pay the premiums, and the life insurance company promises to pay the death benefit if you die.
For example, John buys a $1 million policy good for 20 years. He is 30 years old and doesn’t think anything will happen, but he wants to protect his family, just in case.
At 40 years old, John has a heart attack and dies.
His family receives the $1 million tax-free death benefit and uses it to cover his final arrangements. They have the remainder to continue their life without John and his income while they figure out how to move forward.
That’s a simplified version and applies to term life insurance. The policy is good for a specific term, and because John lost his life within that time, his family got the benefits. It’s not a replacement for John, but helps them move forward with their grief without financial issues.
There is also whole life or permanent life insurance. There are many types that get complex, but whole life insurance is simple.
A whole life policy has a death benefit, like term life insurance, but you pay higher premiums, which the insurance company invests at a fixed interest rate. The cash value, as it’s called, grows over time, and eventually, you can withdraw it or borrow against it.
The difference is if you borrow it, you repay what you borrowed. If you repay what you borrowed, your death benefit remains the same. However, if you withdraw rather than borrow, the insurance company reduces the death benefit dollar-for-dollar.
Many people begin to use their cash value as they age and no longer need such a large death benefit.
This can be a good option for seniors who need money to supplement their retirement. They may no longer need as much of a death benefit because they don’t have a lot of debt and aren’t supporting anyone. Using the funds as a living benefit can help them enjoy life now and have peace of mind, knowing there is a small death benefit for their loved ones to handle what they leave behind.
9 Reasons to Consider Life Insurance
You may wonder why you’d consider life insurance, especially if you’re young. The main reason is life is unexpected!
No one is promised tomorrow, so there’s always reason to protect your loved ones. If you haven’t considered life insurance yet, here are nine reasons to do it.
1. Replace Lost Income
If you are the breadwinner in the family or your income contributes to the household income and bills, life insurance can help replace that income.
As a general rule, most people take out policies that are 10 times their annual income. This ensures your family has 10 years of adequate income in your absence.
There isn’t a rule stating you can only buy 10 years of your income, but life insurance companies will ask about your income to ensure you’re purchasing insurance that you can afford and that is in line with what you make.
Some companies cap your coverage at 20 to 30 times your income, but you can plead your case if you have excessive debts or other financial concerns.
2. Guaranteed Financial Protection
Life insurance ensures your family’s financial protection. No matter your family size or status, you likely have future plans. What happens if you die suddenly?
Without the income you were earning, your family may not be able to live out those dreams despite your wishes for them to do so.
Life insurance ensures your loved ones can continue on the family legacy and fulfill their dreams, even after losing you.
Life insurance also guarantees your loved ones will have enough money to cover expenses and other burdens. If you leave behind debts that your estate must cover, the money your loved ones will receive may be less. In addition, if they must deal with court fees and other hassles, life insurance money can carry them through those times while they figure everything out in your absence.
3. Pay Off Debt
If you have debt that won’t go away if you die, your loved ones need the funds to take care of it. While the burden may not fall on anyone else, it will come from your estate. This may leave less money for your loved ones than you planned.
Having guaranteed insurance coverage ensures your loved ones can take care of your debts. This is especially important if you have joint debt with someone. Leaving them with the debt can put them in a financial bind they weren’t anticipating.
4. Financial Liquidity (Permanent Life Insurance)
If you have permanent life insurance with a cash value, you have the peace of mind of financial liquidity. Knowing you have a cash account to fall back on can help you live life to the fullest.
For example, if you have emergencies or your retirement costs are more than anticipated, your cash value can help you get through those times. You can borrow and repay the funds or decrease your death benefit and withdraw the cash value for other uses.
Knowing you have the liquidity should you need it can ease many financial burdens and stress without worrying that you’d have to sell your home or cars.
5. Tax Benefits
Life insurance has many tax benefits, starting with the tax-free benefit you leave your beneficiaries. Lump sum life insurance payouts are tax-free, so you can relax knowing your loved ones have enough money to cover your expenses without worrying about paying the IRS.
If you have permanent life insurance, it has tax benefits too. Since the money you use to pay your premiums is after-tax, your earnings grow tax-deferred. This means you don’t pay taxes on your earnings, sometimes even after withdrawing the funds.
If you withdraw funds equal to or less than the premiums you’ve paid to date, you will not owe taxes on the money withdrawn, giving you more money in hand to manage your financial obligations.
Always consult your tax advisor before making decisions about life insurance based on tax benefits.
6. Potential for Cash Value Growth
Permanent life insurance is like a forced savings or investment account. Different life insurance policies invest money differently, depending on the rates they pay or the indexes they follow.
When your cash value grows, it can help you pay for large future expenses, such as college tuition, supplement retirement, long-term care, or other major expenses. If you get to a point where you don’t need the death benefit because you have enough money saved, you can use the cash value for living expenses and not worry about how you’ll get by.
7. Coverage for Burial Expenses
In 2021, the average cost of a funeral was $7,848. Account for inflation today, and the costs are much higher. Your family can’t liquidate your estate immediately upon your death, so life insurance proceeds could help them with your end-of-life expenses.
8. Diversify Investments
Diversification is key to avoiding losing everything in a market crash. Putting all your money in stocks or mutual funds could be risky. When you diversify, putting some funds into life insurance forces you to save for the future while deferring tax liabilities.
9.Peace of Mind
No one wants to live with the burden of ‘what if’ on the mind. Life insurance guarantees that your family and other loved ones will be well cared for should you die unexpectedly. You don’t have to worry about where they’ll live or how they’ll put food on the table, allowing you to live life to the fullest without concern.
How Much Life Insurance Do You Need?
Deciding how much life insurance to buy is a big decision that no one but you can decide.
You can use these general rules of thumb to help you get started:
- 10x your salary – The most common method is to buy insurance that covers 10x your salary. However, this doesn’t account for parents who stay home. Even though you don’t make an income, it would cost your family money to replace what you do, so you may need to consider the cost of any services needed to take over what you did and multiply it by 10.
- 10x your salary plus $100,000 per child – If you have children you want to put through college, you may consider buying coverage for 10x your salary plus $100,000 per child for college tuition or to help them start their adult life if they don’t go to college.
- DIME – To get more precise about how much you need, consider adding up your (D) debts, (I) income for the number of years you want to provide, (M) mortgage balance, (E) education expenses.
What type of life insurance should you consider?
Choosing the type of life insurance is another big decision. Most young families start with a term life insurance policy to protect against the unexpected. Once they get settled, have money invested in retirement accounts, and can afford higher premiums, they move on to more permanent life insurance policies.
To decide what type of life insurance you should consider, ask yourself the following:
- Am I covering a specific event, such as paying off the mortgage or paying for college, or am I looking for a long-term investment?
Term life insurance is best when you have a finite period to cover, such as 20 years to pay off the mortgage or 15 years to get the kids through college. You should consider whole life insurance if you want something more permanent to supplement your retirement income.
- Do I want a guaranteed rate of return?
If you want a more permanent policy but don’t have the risk tolerance to handle anything without a guaranteed rate of return, consider whole life insurance. You don’t have to make any decisions with it. You pay your premiums, and any amount beyond the death benefit premium is invested for you.
- Do you need coverage only for your end-of-life expenses?
If you only need coverage for your burial and other end-of-life costs, you might consider final expense insurance, which is a small whole-life insurance that has a small death benefit and accumulates a cash value.
What Affects Life Insurance Premiums?
When considering the importance of life insurance, it’s crucial to know what affects the premiums. You must pay the premiums monthly or any other interval to have life insurance in effect. If you die and your life insurance premiums aren’t paid, you risk your loved ones not getting a death benefit when you die.
So, what affects life insurance premiums?
- Age – The younger you are when you buy life insurance, the cheaper it is.
- Health – Life insurance companies check your health history and do a health exam to ensure you aren’t at risk of premature death.
- Habits – Smoking, drinking, or participating in risky habits can increase your life insurance premiums because you’re at a higher risk.
- Death benefit amount – The more insurance you purchase, the higher the premiums will be.
- Type of policy – Term life insurance has the cheapest premiums but limited benefits. Permanent policies, like whole and universal life, are more expensive but grow a cash value.
Common Myths About Life Insurance
Many people assume they don’t need life insurance. They let themselves believe the narrative that ‘they’ll be okay,’ and then their families find out the hard way.
Some of the most common myths people believe aren’t true and shouldn’t hold you back from getting life insurance.
- My employer offers life insurance. Many employers pay for a group life insurance policy, but it’s a mere fraction of the amount you’d need to protect your family.
- I can save money myself – You might be great at saving, but you can’t save hundreds of thousands of dollars overnight; what if something happened to you tomorrow?
- It’s too costly – There are many options for life insurance, making it affordable for people with any budget.
- I’m young and healthy. No one is promised tomorrow; you should never assume something won’t happen to you. Young families have the highest risk of financial destruction without one person’s income, so it’s important to protect it.
What is the most important use of life insurance?
Life insurance’s primary use is to pay the deceased’s final arrangements and protect the finances of those he/she left behind. It protects your loved ones and is one of the greatest gifts you can give your family.
What are the four living benefits of life insurance?
If you have a life insurance policy with living benefits, you may use it in several ways:
- Borrow against the value
- Surrender the policy
- Withdraw cash and decrease the death benefit
- Use the cash for long-term death benefits
What are five things not covered by life insurance?
Like any insurance, life insurance has exclusions. They will not cover death by suicide, criminal activity, an act of war related to drugs or alcohol, or an act of terrorism.
Who doesn’t need life insurance?
No one doesn’t need life insurance. Unless you’re financially set and have enough money saved for your loved ones to live on for several years and also cover your death benefit, you need life insurance.
Don’t overlook the need for life insurance. Whether you’re single or have a family, there are always factors to consider, including your final arrangements. Life insurance is a gift to those you leave behind to help them easily handle your estate while processing the loss.