All types of insurance can help reduce the risks of a financial plan. Whether you’re trying to reduce the risk of loss of income, ability to perform your job, catastrophic damage to a large asset such as a home, or general liability, if there’s a risk, generally, insurance can be purchased to cover it. One of the most common types of insurance that almost all financial plans should at least consider is life insurance. Life insurance reduces the risk of a future loss of income and can help reduce overall household debts or fund future goals in the event of a tragedy. This article will discuss the most common type and the benefits of term life insurance.
What is Term Life Insurance?
Term life insurance is the most basic, common type and arguably the most useful. It provides a set death benefit for a set period. For example, a policy might be described as a $1,000,000 death benefit for 20 years. If the underlying insured person were to pass within 20 years after purchasing the term life insurance, then the policy’s beneficiary will receive $1,000,000. During that period, the policyholder will pay an annual or monthly premium to keep the policy in place. If the premium isn’t paid, the policy lapses. It’s as simple as that!
Generally, term life insurance is best used to replace the future loss of income of the insured and/or to enable the beneficiary to pay off existing debts (such as a mortgage), or fund future goals (such as education costs for kids).
Term Life Insurance Use Case
When you’re married or have kids, term life insurance almost always makes sense to implement. Let’s outline a scenario and how term life insurance may benefit a hypothetical family.
The Jones family consists of four members: two spouses and two kids. The spouses both earn similar incomes of $150,000 per year and carry a mortgage debt of $500,000. The kids are ages 5 and 2 and are currently saving for their children’s college expenses in a 529 savings plan. The Jones have around $50,000 in cash for their emergency fund but not much else liquidity, with almost all their investments tied up in retirement accounts. From a financial planning standpoint, a large risk to their long-term plan is if one or both spouses no longer earned their income and couldn’t pay their mortgage and/or fund their children’s college goals. Therefore, they can use term life insurance to reduce the risk of these two scenarios significantly.
The Jones family should purchase term life insurance for $750,000 for 20 years at a bare minimum. This would be a baseline, simplistic way to approach life insurance. With the assumption that after 2o years, most of the mortgage will be paid down and the children will have entered or completed college, life insurance would no longer be needed. They could also consider “laddering” the insurance and purchasing around $500,000 for x amount of years and another $250,000 for a lesser or greater amount of years, depending on when the amount of insurance needed changes. However, if the Jones’ wanted to purchase enough insurance to “replace” all future income of both spouses, the amounts would likely be much larger and in the millions.
There’s generally a baseline amount of life insurance a financial planner can recommend; however, above and beyond that, it becomes more of an art than a science. If your family is more comfortable with larger amounts of life insurance and fully replacing future income, purchasing more isn’t an issue. With the caveat that it will be more expensive as long as the policy premiums don’t hinder your cash flow or hurt other financial goals.
Other Benefits of Term Life Insurance
Term life insurance is extremely cheap relative to the risk it reduces and the benefits it can provide. For a young couple in their 30’s with relatively good health, a term insurance policy for $750,000 and 20 years may cost somewhere between $250-$450 annually. This premium is “locked” for the term of the policy. Therefore, inflation and your future health don’t impact the rate you pay for the policy. In contrast to what you pay for through group policies, many employers offer. They typically increase their premiums if you’re to leave the company or “re-up” the group life insurance in future years.
As mentioned above, term life insurance is also simplistic. It’s easy to purchase, maintain, and understand as a consumer. Whereas its counterparts are oftentimes complicated and expensive. Life insurance policies known as Whole Life or Universal Life do contain a death benefit but also contain other bells and whistles that, in the vast majority of cases, are NOT NEEDED. If you’re primarily looking to insure against the risk of loss of income, term life insurance will always be the best option over its more expensive and complicated counterparts.
The Bottom Line
Term life insurance is a staple of any strong financial plan. Often, it can be purchased at a low cost and provides your family the peace of mind that they’ll be financially taken care of in the event of a tragedy. If you’re looking to review your life insurance strategy or determine what makes the most sense for you and your family, schedule a free consultation today!