Why You Need Life Insurance

Protect the people you love most by planning to provide for them after your gone

If you die an untimely death, you don’t want your family to suffer financially. That’s why you need life insurance.  Because a good life insurance policy effectively allows you to care for your family financially from beyond the grave.

Life is temporary. Sooner or later, we all die. And though our average life expectancy extends well into our 70s, that’s no guarantee. There are a host of risk factors that could cut your life short. So you need to be financially prepared to handle the consequences of an unlikely death.

In this series, Understanding Insurance, we’ve been studying some of the fundamental concepts of insurance and seeing how they apply to our financial lives. We’ve already covered health insurance and auto insurance, and talked about ways to reduce your risk factors and your insurance premiums. Today’s discussion is about life insurance, one of the most important purchases that you can make for your family.

How does life insurance work? Let’s say you buy a $100,000 policy on your life with a 10 year term. If you die within 10 years from the time that you bought the policy, the beneficiaries of your policy get a check for $100,000. That money can help to cover the costs of a funeral and other end-of-life expenses. It can also go toward meeting the needs of your family for a long time to come.

Who Needs Life Insurance?

Do you have any dependents — anyone who counts on you to provide for them? If so, then you probably need life insurance.

Your income provides for your families needs. But what would happen to your them if you died unexpectedly?

They may get some benefits from from Social Security. But those won’t make up for the loss of your income. That’s why you need life insurance. You buy life insurance hoping your family will never have to collect it. But making this purchase can give you a lot of peace. Because if something terrible happens to you, your family will be protected financially.

Some people believe that everybody — even children — should have life insurance policies. I don’t subscribe to that idea. A good emergency fund should allow you to cover the costs of a child’s funeral should such a tragedy occur.

Instead, I believe life insurance is most important for adults with dependents. Single adults probably don’t need life insurance. But married people need life insurance to provide for their spouses and children in case they die.

What Kind of Insurance to Buy

There are a lot of different kinds of life insurance out there. But the only kind of insurance that makes financial sense is term life insurance.

Term life insurance is simple and cost effective. When you buy a policy, you select the term that it will cover — usually 10, 20 or 30 years. If you die within that time, your family gets paid the face value of the policy. If the term expires while you’re still alive, you can sign up for a new policy on a new term.

Term life insurance is very affordable — usually just a few dollars per month for every $100,000 in coverage. The shorter the term of your policy, the less the policy costs. But long-term policies have their own benefits. They lock your rates in for decades. Short-term policies, on the other hand, gradually become more expensive as you age.

Term life insurance protects your family during the years when they can least afford to lose you. If you’ve stayed out of debt, saved and invested well, however, you should have a strong portfolio by the time you retire. Your family can live on the returns from that money after you die. So you don’t really need insurance when you’re 70 years old.

How Much Insurance to Buy

So, you want to buy term life insurance. How much do you need?

Probably a lot more than you think. The best strategy  is to buy enough to replace your income should you die.

Let’s say that you earn $50,000 each year that your family counts on. If you die and you have a $50,000 insurance policy, that replaces your income… for all of one year. It doesn’t go very far. So instead of a small policy like this, you want something that will continue to provide for your family year after year.

You want enough insurance that your family can get a huge payout. Then they can put that money into mutual funds that will pay returns every year. And the amount of those returns should replace your income every year.

Since good mutual funds return an average of 10 percent or so each year, you should buy a life insurance policy that is worth 10 times your income. If you earn $50,000 per year, you need a $500,000 policy.

Life Insurance and Mortgages

If you have a house with a mortgage, you may want to add the balance of your mortgage to the value of your life insurance policy. If you do that,  your surviving spouse could pay of the house immediately when you die. Then your family can use what’s leftover to invest for income replacement. This is a much more economical option than the “mortgage payoff” insurance that mortgage companies sell. Skip their expensive insurance and add the value of your home into your regular insurance policy.

There are a lot of subtleties to life insurance, and your individual decisions will depend on your unique life circumstances. You should work with a good insurance company you trust to set up the policy that will be best for your family.