Life Insurance: How Much and What Kind To Buy

How much life insurance do you need? What type is appropriate? You should review your life insurance needs each time you have a major life event. Here is what you need to know to properly plan for your life insurance needs to buy enough and to get the most for your money.

How Much Life Insurance Do You Need?

Determining how much insurance to buy requires you to invest some time in calculating...

• Your current annual household expenses
• Your assets, debts, and other sources of income.

We've provided a worksheet, which we will refer to in our discussion.

Tip: Find out how much insurance you need before considering which type of insurance to buy. Having enough is more important than having the right type. You should provide for your insurance needs immediately, although you can always switch to a more cost-effective or investment-oriented type of insurance later.

The ideal amount of coverage is the amount that would allow your dependents to invest the insurance proceeds after your death and maintain their desired standard of living without touching the principal. Although the old rule of thumb to buy five, six or seven times your annual salary may serve as a starting point, it is no substitute for making the calculations to find out how much you really need.
By using the worksheet and our explanations, you will be able to make a fairly good estimate of your insurance coverage needs. You will need to make some assumptions about your family's future.  It's important to be as accurate as possible in filling out the worksheet since an underestimation could lead to your being underinsured, and an overestimation will lead to money wasted on unnecessary coverage.

Term Insurance

For individuals age 40 or less, a term policy will almost always be less costly than a whole life policy. Although term policies do not build cash values, many are convertible to whole life policies without a physical exam. Thus, a term convertible policy may be a good option for someone who is under 40. There are various types of term insurance, which we will discuss briefly here.

• Renewable. a renewable term policy is the most common type of life insurance where the policy renews automatically on a renewable term, e.g. every year, every 5 years, every 10 years, or every 20 years--the most popular renewal term. You do not need to take a physical or verify the fact that you are employed. The premium goes up at the beginning of each new term to reflect the fact that you are older. Most renewable term policies can be renewable until you reach age 70 or so.
• Re-entry. With this type of policy, you must undergo a physical exam after a certain period, or pay an extra premium.
• Level. With level term policies, the premium is guaranteed to stay the same over a certain period. This period may be shorter than the term of the policy. Nearly all life insurance bought today is level term insurance.
• Decreasing. With a decreasing term policy-a good option for insuring mortgage payments-the face amount of the policy decreases over time while the premium payments remain the same.
• Return of Premium. Some insurers offer term life with "return of premium." Typically, premiums are significantly higher and they require keeping the policy in force to its term.
  
  

  Cash Value Insurance

  There are four types of cash value life insurance: (1) whole life, (2) universal life, (3) variable universal life and (4) variable whole life. The first two types are the most common and have a guaranteed cash surrender value; in the last two types, the cash surrender value is not guaranteed.
  Whole Life. This is the traditional life insurance policy. It provides a death benefit, has a cash value build-up, and sometimes pays dividends. You do not need to renew a whole life policy. As long as you pay your premiums, you will have coverage, usually until your death. The premium for a whole life policy remains the same for the amount of time you own the policy; the premium is "level" in insurance parlance. Thus, when you are younger, the premium you pay for whole life will be greater than what you would pay for term insurance but when you are older, the premium will be much less than a term premium. Part of each premium goes into the cash value of your policy. Your cash value, which is actually an investment, is guaranteed to grow at a fixed rate. You do not have to pay current income taxes on the growth in the cash value it is tax-deferred.
  

  Tip: You can borrow against your cash value at a rate that is usually better than the prevailing consumer lending rates. If you die with an outstanding loan amount, the loan amount, plus interest, will be subtracted from your death benefit.

  Dividend-paying whole life policies-termed "participating" policies are usually offered by mutual life insurance companies. Mutual life insurance companies are generally owned by policyholders while other insurance companies are owned by shareholders. The dividends are refunds of insurance premiums that exceed a certain level. They are paid when the insurance company does well during a quarter or a year. Of course, premiums for participating policies are usually higher than those paid for non-participating policies.