By CHAS P. SMITH, CPA/PFS and Derek Oxford
Excerpts Published Thursday, November 6, 2014 by Lakeland Ledger
If your investment pile of assets is not sufficient to replace the income stream of the bread winner in the family then life insurance is an inexpensive way to replace that lost income. However, the amount of life insurance may not be just to replace your annual salary but also the potential earnings of the non-working spouse who chooses to stay home and care for the children. In large estates, life insurance is often used to pay for estate taxes. Each person or family has certain goals in mind where life insurance can play an important role.
HOW DOES LIFE INSURANCE WORK?
Life insurance provides payment at death, but does not provide a benefit for the insured while alive, except peace of mind. Because life insurance is typically paid for with after tax dollars, benefits received from a policy are usually free of income taxes to the beneficiary. The benefit could cover a variety of needs including the payoff of a mortgage, college expenses, or other future needs such as the maintenance of a standard of living for your spouse and loved ones.
WHAT LIFE INSURANCE IS AVAILABLE TO YOU?
Life insurance comes in two general categories: term insurance and permanent insurance. Term policies cover a specific term, or period of time such as 5, 10, 20, or 30 years. At the end of that term, the premiums stop and the death benefit is void. For permanent insurance, premiums are usually significantly higher. The premiums can be paid up front in a lump sum or over time. Most permanent policies offer a cash surrender value (savings account build-up) and, at the end of term the policy is fully paid up, and no further premiums are required to secure to the death benefit.
Term insurance is more affordable and can provide an adequate death benefit coverage for most people. A good analogy is comparing a leased car versus the purchase of a car. Leasing is cheaper in the short term and can enable one to drive a great car. While purchasing a car may be more expensive, but you own the car once the loan has been paid off.
IS IT TIME FOR YOU TO BUY LIFE INSURANCE?
Do others depend on your income? If you answer yes, you should have some amount of insurance to help your dependents if you were to pass away. Breadwinners often need coverage first, then more coverage can be added for other family members depending on their role with the family. The non-working spouse is often insured to pay for caregiving expenses for children until they become adults. Other areas where insurance coverage could be increased or purchased would be after a life event, such as marriage, a home purchase, birth or adoption of a child, or a sudden and substantial increase in pay from a new job or promotion that would affect your standard of living.
You may already have some form of insurance through a group plan with your employer, but if you change jobs that policy is often non-transferable. Accordingly, it is prudent to supplement a group policy with an individual one to be properly insured in case of death.
HOW MUCH LIFE INSURANCE DO YOU NEED?
A simple way to determine the minimum amount of life insurance needed is to multiply your annual salary by 10, so a person making $50,000 per year would need on average $500,000 worth of life insurance. However, this calculation does not consider other expenses that may be needed after the insured passes away. These additional factors such as education funding or care for a disabled child may bring the total to 20 times your annual salary, or more. Each family situation may call for a specific need for coverage, and a qualified financial advisor will probe using questions to ensure adequate coverage is achieved through life insurance.
Source: Fidelity Investments
Next time: What to look for in buying life insurance
Chas P. Smith, CPA/PFS is president and chief investment officer of CPS Investment Advisors. Derek Oxford is a contributing author of this article.