How much life insurance coverage should you have? Here are some things that a typical person should take into consideration.
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Income Replacement
Financially speaking, one of the biggest impacts that your death will have is the loss of income. If you’re married or have dependents, you should figure out how much of your income you need to replace so your family can maintain its standard of living. The first step is determining how long you would like your income to be replaced for. Do you want it to last ten years, twenty years, or for the rest of your beneficiary’s life? If you have a spouse, one thing to consider is whether he or she will continue working if you pass away or if he or she will be taking care of the children full time. If the spouse decides to continue working, the total amount needed here gets reduced significantly. Keep in mind that the money received here wouldn’t just be sitting under the mattress; it would be earning interest somewhere. To figure out the exact numbers here, you’ll likely need a financial calculator.
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Debt
Something that would be good to know here is whether any debt you have will be passed on to somebody else in the event of your death. If that’s the case, you should have enough life insurance coverage to make sure that someone you love doesn’t end up paying off the money that you borrowed. Credit card debts, school loans and car payments all fall under this.

Something special to think about is the mortgage. Would you like the house to be fully paid for if you pass away? If you aren’t a homeowner and are renting instead, calculate how many years worth of rent you would like to leave behind for your beneficiary, if at all.
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Children’s’ College Education
Do you want your kids’ college education paid for if something happens to you? Do you want to pay for all of their tuition or just part of it? Right now, the average cost of attending a four year university is somewhere around the range of $50,000 and is on the rise. Of course, having access to financial aid and/or going to a community college first would change this number dramatically and is something you should take into account.
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Other Expenses
Do you need to have extra insurance to cover child care? Is one of your beneficiaries disabled and has special needs? Figure out how much you need to cover these other expenses and for how long.
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Final Expenses
As I mentioned before, dying can be expensive. Final expenses include a number of different areas such as funeral expenses, medical costs, and attorney fees. If you’re leaving behind a large inheritance, you have to take into account estate and probate taxes as well (that’s something that deserves a whole post by itself). Unfortunately it’s impossible to predict how much all of those other expenses will cost. I typically recommend having a minimum of $50,000 for this area, if not more. It’s better to overestimate than underestimate for this area. [break]
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Example
Let’s say that Jack and Jill just read this post and Jack is trying to figure out how much life insurance coverage he should get. They’re both 35 years old, they both make $50,000 a year, and they have a child, Jane, who is 8 years old. [break]
Income Replacement
If Jack passes away, he would want Jill and Jane to maintain the same standard of living that they have now for the rest of their lives. With Jack out of the picture, he figures that Jill and Jane would only need 70% of the current total household income before tax ($80,000) to continue living the way they do. Jane said she would continue working if Jack passed away, so Jack only needs to replace $20,000 of his $50,000 current income. He assumes that if the income replacement money gets invested conservatively, it could earn an average of 5% a year. So to figure out how much money Jack needs for income replacement, we take $20,000 divided by 5% which gives us $400,000. In other words, if Jill takes $400,000 and invests it so that it earns on average 5% a year, then she will be able to withdraw $20,000 a year for the rest of her life. [break]
Debt
Jack doesn’t have any debt to his name other than a mortgage. Right now Jack and Jill still have twenty years left on their mortgage and they still owe $300,000. He wants the house to be fully paid off in the event that something happens to him.[break]
Children’s College Education
Jack is willing to help Jane pay for her college education, but not all of it. He believes that Jane should work during her college career to pay for part of her education. That way, not only will she gain valuable job experience, she’ll place more value in her degree because she paid for part of it herself. He’s willing to set aside $20,000 for Jane’s education. [break]
Other Expenses
Jack can’t think of any other expenses that might come up. He believes that the extra $20,000 a year from the income replacement should be enough to take care of things. [break]
Final Expenses
Jack thinks that $50,000 in coverage will suffice for final expenses. [break]
Total coverage needed: $400,000 for income replacement, plus $300,000 to pay off the mortgage, plus $20,000 for Jane’s education, plus $50,000 for final expenses puts Jack’s total life insurance needs at $770,000. So if Jack passed away today, his family would need $770,000 so that they could live out the life he envisioned them living.[break]
Now that we’ve figured out Jack’s total life insurance needs, all he has to do is get $770,000 in coverage, right? Not so fast. There are a couple things to take into consideration still.

Ten years from now, Jane is going to turn eighteen and will probably be able to provide for herself, at least in part. Four or five years after that, she’s going to be done with college so Jack won’t have to worry about having that expense covered any longer. Twenty years from now the mortgage will be paid off so Jane won’t need the $300,000 in coverage to pay off the house. The point that I’m trying to get at is that life insurance needs change over time and so Jack is going to have to reevaluate his polices to determine if he’s underinsured and leaving his family unprotected or over insured and paying for something he doesn’t need.

Additionally, he needs to think about what combination of policies he’s going to use to cover his insurance needs. How much of the coverage is going to be term insurance and how much is going to be permanent? Is he going to use whole life, universal life, variable life insurance or some mixture of three?

There are many different kinds of policies out there and you want to use the ones that fit your needs the best. Every person’s situation is different so there’s no catch all policy that can be recommended to everyone.
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Previous life insurance post: Why Life Insurance is an Important Part of Your Financial Plan

Whenever I see anything related to personal finance, I often hear about what should be done with savings or how investments should be directed. Something I noticed a lot of people have left out is life insurance. They view it as an entity that’s completely separate of their financial plan when they’re one in the same. Life insurance plays just as important of a role as savings or investment; savings and investments represent the offensive side of a financial strategy whereas life insurance represents the defensive side. In my opinion, life insurance is one of the most underrated and misunderstood financial tools out there. You can start an investment at any time. It doesn’t get more expensive as you get older and it isn’t something you will ever have to qualify for. Life insurance is exactly the opposite. Let’s also look at it from a protection point of view. Suppose today you put $100 in a mutual fund. Tomorrow on your way to work you get into an accident and are instantly killed. What’s that $100 in investments going to do for your family compared to what it could have done in life insurance? That same $100 could have provided thousands of dollars in death benefits. Which would you rather have, thousands of dollars, or just $100?

Life insurance, like any other kind of insurance, is there you protect you and your family from any unforeseen circumstances that might come up. In this case we’re talking about death; it’s there to protect your family in the event that you pass away. Unlike every other kind of insurance out there like home insurance, auto insurance, or liability insurance, life insurance is the only “when” insurance. All the other types are “what if” insurance. What if something happens to your home, what if something happens to your car, what if someone decides to sue you, etc. It’s possible all these things can happen, but none of them are guaranteed to happen. Life insurance is the only one where we know the end result; nobody lives forever. The question isn’t whether or not if you will die, it’s when you will die and it’s up to you to make sure that your loved ones, whether it’s your parents, spouse, or children, are going to be financially able to cope with your death.

I’m not sure if you’ve ever had to deal with the death of a loved one before, but dying can cause both an emotional strain and a financial strain. There are final expenses to consider which include a number of different areas like funeral expenses, medical bills, various attorney fees, and estate and probate taxes. All of these costs add up. I’ve seen final expenses run as little as $20,000 all the way up to $500,000. Not having life insurance means that your family will have one more thing to worry about when you pass away.

A common misconception is that the only people who need life insurance are older people, typically married with children. This could not be further from the truth. In my opinion, everyone could use life insurance. It is the tool that you use to make sure that even though you’re not there, your family will still be able to carry on.

Let’s say you’re young, single, and have no dependents. If something happens to you then it’s likely that your parents are going to be the ones who have to pick up the final expense bill. How many people do you know that were in their twenties or thirties that passed away peacefully in their sleep? That doesn’t happen very often; when a young person dies it’s usually due to a tragic accident. And typically with tragic accidents come hospital bills. How would you feel if you passed away and you left your parents with a $50,000 final expense bill? How do you think they would feel? What do you think that’ll do to their retirement and any other things they might have been saving up for?

If you’re married with kids, then this becomes even more important. Think about your spouse. If you were suddenly taken out of the picture, would he or she still be financially able to continue to live the lifestyle you two had before? Would he or she be able to pay the rent or the mortgage? Pay off any debts you might have accumulated? Raise your children and send them off to college?

If you’re older and have a lot of assets, then the picture becomes more complicated. If your spouse has already passed away, then your kids are probably going to be the ones who pay for the funeral expenses and any hospital bills. On top of that, they’re going to have to deal with estate and probate taxes on the inheritance you left behind for them. These taxes are paid for in cash so if you don’t leave behind enough liquid assets, then your kids will have to scramble to come up with that money.

Hopefully you’re starting to see the importance of this financial tool. However, just having any policy isn’t enough. You want to make sure that you’re adequately covered so that you’re not underinsured, leaving your family unprotected or that you aren’t over insured and paying for something you don’t need. You also want to make sure you have the right type that fits your specific needs as there are many different kinds of policies out there. Lastly, you want to make sure that the insurance will be there for your family when they need it the most.

So how do you figure out how much life insurance do you need? That’s something I’ll cover in my next life insurance post.
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Next life insurance post: How to Determine Your Life Insurance Needs
Previous life insurance post: Understanding the Difference between Term Life Insurance and Permanent Life Insurance

Figuring out what kind of life insurance policies fit your needs best can be overwhelming at times, especially with the number of different kinds of policies that exist. Talking to a life insurance agent, who’s paid by commission, probably isn’t going to help either. To help you with this, I’m going to be writing a series on understanding the different kinds of life insurance products that exist and how they work.

Let’s start out with the basics. There are two main types of life insurance: temporary (or term) and permanent.
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Term Life Insurance
The most common type of term life insurance is group term, which is often provided by employers. If you have life insurance through work and you’re not sure what kind you have, it’s more than likely going to be group term. Group term is an inexpensive type of policy, provides decent coverage, and is available to everyone in the work place. The catch is that you must remain with that employer in order to be covered by that plan. This means that changing jobs, getting laid off, or retiring will all cause your coverage to cease.

Term insurance is also something that you can purchase on your own outside of work. The coverage lasts for a predetermined amount of time, so it could be for ten years, twenty years, until you’re age sixty-five, etc. Term is typically used for things like protecting college expenses, ensuring that a mortgage is covered, and making sure that short term debt is paid off. In the short run, this kind of policy is very cheap to buy because it’s only going to be there for a limited amount of time. In the long run, it can become very expensive. If you’re twenty-five years old and are in good health, you would be able to get a large amount of term insurance for a pretty low price. Let’s say for example that you got a thirty year contract for $500,000 in coverage for $50 a month. The policy payments are based on the age at issue, so for the next thirty years, you’ll be paying the same $50 a month like you did when you were twenty-five, all the way until you hit fifty-five. When insurance contract expires at fifty-five years old, it’s going to be a lot more expensive to renew it because it’s going to be based on your new age. The same $500,000 in coverage could run you upwards of $500 a month. And that’s also assuming that you can renew it, as you may not be insurable anymore. Having a heart attack, a stroke, or cancer can cause your insurance rates to hike up significantly or it might make you ineligible all together. In addition to that once the contract expires, the coverage is gone. You could die the day after your insurance ends and the life insurance company won’t have to pay your beneficiaries a dime. If nothing happens to you during your period of coverage, all the money that was paid into the insurance won’t be returned to you.
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Permanent Life Insurance
The other type of life insurance is permanent insurance. These policies are referred to as permanent insurance because they will stay with you forever, until you die, provided that you keep them in force. There are three main types of permanent life insurance: whole, universal, and variable life. There are also combinations of those three, but we’ll get into that another time. Permanent insurance is commonly used for income replacement, in case the primary income earner passes away, and for final expenses. Examples of final expenses are funeral expenses, medical bills, attorney fees, estate and probate taxes, etc. In the short run, permanent insurance is a lot more expensive than term insurance. In the long run however, permanent is a much cheaper alternative than term. Generally with permanent insurance, the rate that you pay when you get the policy is going to be the rate that you pay for the rest of your life. If you got permanent policy when you’re twenty-five, you’re going to be paying that same premium over the entire policy, even if you live to be 100. Permanent policies also build up cash value, which is your equity in the policy that you can redeem should you no longer want the policy. Additionally, you lock in your insurability because with permanent insurance, you’ll never have to renew it, so you don’t have to worry about health problems affecting your insurability.
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Getting term insurance is similar to renting an apartment. Every month that you live in an apartment, you pay rent. From time to time, the landlord is going to increase the rent. Suppose you live in that apartment for thirty years. After thirty years of paying rent if you decide to move out, you won’t have anything to show for the past thirty years of payments. However, you at least had some place to live during that time.

Purchasing permanent insurance is like buying a home. The cost upfront is a lot higher than renting an apartment: you have to make a down payment, pay the real estate agent, and maybe even pay home owner association fees. On top of that you still have to make your monthly mortgage payments which tend to be more expensive than rental payments. But as you make your monthly payments, you build up equity and after thirty years of payments, you now own your home.

The differences in these two kinds of insurance are huge and it would be beneficial to know what kind you have. If you’re thinking about getting life insurance, make sure you get all the details first so you know what you’re buying. There are pros and cons to each type of insurance; most people use a combination of temporary and permanent life insurance to meet their needs. Each person’s situation is different so how much of each kind of coverage that you need depends on you.
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Next life insurance post: Why Life Insurance is an Important Part of Your Financial Plan