Life Insurance: How
Much and What Kind?
Life insurance can be an affordable way to provide for our
children, spouse, a sibling, aging parents and others if we should die while
they are depending on us. Life insurance proceeds can provide extra income to help
pay ongoing household bills and child care; pay off a mortgage, credit cards
and other debt; pay for college; and pay funeral costs and other final
expenses. (Life insurance also plays a vital role in business succession
planning and it has numerous applications in estate planning.)
A simple way to determine the amount of life insurance
needed for income replacement purposes is to multiply the annual income to be
replaced by the number of years it will be needed. If the insured earns an
income, use the amount actually contributed to the household (after personal
expenses and taxes). If the insured is a stay-at-home parent and does not earn
an income, determine how much will be needed to pay someone to take over those
responsibilities. As an example, a dad who wants enough life insurance to
replace his income for 20 years (until his children have completed college)
would take the amount of annual income he wants to replace and multiply that by
20. He may want to add enough to pay for college and other expenses. The total
amount is how much life insurance he needs. This is called the “face value” or
“death benefit.”
Basically, there are two kinds
of life insurance: term and permanent.
Term life insurance provides coverage for a set number of years, or
term. It is pure insurance, and is similar to insurance on a car or home. It
can be a good choice when coverage is needed for a certain number of years; for
example, until the kids are out of college or the mortgage is paid off. It is
also less expensive than whole life, and is least expensive when the insured is
young and healthy. For these reasons, term life insurance is a popular choice
for young families.
Permanent life
insurance, on the other hand, does not expire at the end of a specified term
(assuming the premiums are paid). Generally, the coverage stays in effect
during the insured’s lifetime and the premium, depending upon the type of
policy, can either stay the same or fluctuate based upon the financial
performance of the policy. Permanent policies also build cash value over time
that can be borrowed from the policy (reducing the proceeds paid at death), can
be used to help pay the premiums, or can be refunded if the policy is
cancelled.
The amount a family pays for life insurance must be a
reasonable and manageable expense. The cost will depend on the amount, kind
(term vs. permanent), and the age and health of the person to be insured. If
the cost to replace income for 20 or 30 years is too much for the family
budget, one option is to cover five to seven years of expenses, which will give
the family time to cope and adjust after the loss.
If you have more questions, contact a San Francisco Estate Planning Attorney today.
