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Life Insurance Needs for the Young Family
So you got married, bought a house and started a family. Life is good. The job is going well, your company has a 401k match program and you began making contributions. Great, you’re in the process of lining up all the financial pieces to ensure a bright and prosperous future for you and your growing family. The question I have for you is “have you addressed your need for life insurance?”. It’s probably not something you thought too much about up to this point, after all it’s certainly not the most pleasant of topics. But as unpleasant as it is, the question needs to be asked, “How will your family manage financially if a primary bread winner should pass away?”.
Having spent over twelve years working for one of the world’s largest insurance companies, holding an MBA in Finance and having spent five years in the financial planning field, I believe I am in a position to give you some sound advice on life insurance.
Do I need Life Insurance?
The first question you may ask is, “Do I need it”? And the answer is yes, unless you are independently wealthy, in which case we should be talking about estate planning. The question you need to answer is “how will your spouse and children get by without your income for the next 20 years?”. If the answer to that question is “I don’t know”, then you need life insurance.
How much do I need?
This will obviously vary from family to family based on each family’s unique financial situation. You can search the term “Life insurance needs estimator” on the web to find some very useful tools for estimating your life insurance needs. A factor just as important as the dollar amount of the insurance you will need is the duration of the need. For example, if you have a mortgage that has 20 years left on it, you have a need on that liability for 20 years. There is no need to insure the obligation beyond the liability period. Remember this, life insurance is intended to compensate for the financial impact that results due to the loss of a financial provider. It is not intended as a means to achieve financial gain.
What type, term or permanent?
In my opinion, this is a very simple answer. Term.
What is the difference?
Term is pure insurance addressing the life insurance need. In a way term is like the insurance policies you are familiar with in other insurance lines. Take for example property and casualty insurance. Your auto insurance coverage runs for a term of six months to a year and then it is up for renewal. If for some reason you sold your car and gave up driving, would you still carry auto insurance? Of course not. If a financial liability were dissolved would you still look to insure it? Of course not. When your children eventually graduate from college are you still going to carry insurance to cover college expenses in the event you should pass away? Of course not.
Permanent insurance is insurance that you may retain for life. There are a few variations of permanent life insurance such as whole life and universal life, which I will not get into. If you are interested however, you can find a plethora of information concerning the different types of permanent insurance on the web.
Permanent insurance is more expensive than term insurance, a lot more expensive. In essence, permanent insurance combines a savings plan with your life insurance. The portion of the insurance payment that is not allocated to the insurance premium component goes into a pseudo savings account. This accumulates and grows tax deferred over time, just as it would if you had put that extra money into your 401k or IRA. You can borrow against this money, just as you can with most 401k plans. Also keep in mind your 401k is funded with pre-tax dollars as are some IRAs. Your insurance premium is not. A Roth IRA is not funded with pre tax dollars, however a Roth IRA grows tax free. One other important point to consider is the that fact that some states impose a premium tax on life insurance premiums. For example, if the premium tax is 2%, your savings starts with a 2% deficit. If you pay $100 in excess premium, you start off with $98 in your pseudo savings account. Not a good deal.
The bottom line
The bottom line is this, are you looking for life insurance or a retirement plan? Is the answer both? If it is then open up an IRA or join your companies 401k plan and purchase some term life insurance. There is really no reason to combine your retirement savings with your life insurance. Well, let’s say no “good” reason.
The young family
This is the point in your life when the need for life insurance is at its peak. Let’s say you just completed an online needs estimate and it is determined you should have $1,000,000 in life insurance coverage. If you and your spouse are both working you would perform the same analysis on your spouse. When you price term vs. permanent you realize there is no way you can afford the permanent insurance, don’t worry, you don’t need it. You end up with a $1,000,000, 20 year renewable term policy on you and maybe $500,000 20 year renewable term policy on your spouse. Let’s say you and your spouse are 28 years old, you have 2 children, ages 2 and 3 and you have a $250,000 30 year mortgage with 28 years left to pay.
My how time flies
Now we move ahead 20 years. You have 8 years left on the mortgage which is now down to $75,000, both children still live at home, however, your 3 year old is now 23, has graduated college and has just entered the work force within the last year. Your 2 year old is now 22 and just graduated college, congratulations! You receive a notice that your term policies are expiring, however you have the option to renew. Now when you look at the rates you realize it cost considerably more to insure two 48 year olds than it did two 28 year olds. Time to panic? No, not at all. Your insurance needs have diminished significantly. You determine that you really only need $300,000 in life insurance and your spouse only requires $150,000. The premium remains the same since the decreased face value of the policy was offset by the increase in age. This is a pattern you should continue as the years go by. Review your insurance needs at renewal and adjust accordingly.
Time to retire already?
You made it, you have no idea where the time went, it went by so fast, but you and your spouse made it. And remember that IRA and 401k account you started when you were so young? Guess what, it has grown considerably over the years, in large part due to your disciplined and consistent savings practices coupled with the selection of suitable investment options. You now plan on selling your primary residence, which is paid off, and downsizing to a smaller less expensive home in the area the both of you have always dreamed of retiring to. Before you move, you start to make preparations concerning your address change and you realize you will need to notify your life insurance company. This reminds you to reassess your insurance needs. At this point you may determine that you have no more life insurance needs, or you may find that all you need is a small $10,000 final expense policy. You look back and realize with a sense of satisfaction, you did it right!
Shopping for life insurance
I am not one to stereotype, but if you end up with an insurance agent at your home, be prepared. It has been my experience that you will be pushed to buy everything with the exception of what you really need. And if your situation parallels the situation described in the article above, you need term. You don’t have to take my word for it. Do your own research. In the vast majority of cases you will find that financial advisors and counsels with no association with the insurance industry will guide you towards term policies. Those who stand to make a buck are going to attempt to steer you into a permanent policy. Remember, insurance agents have been overcoming consumer objections for years. They are pros at it. You are simply someone who is looking out for the well being of your family. Never allow yourself to be pressured into buying something you are not comfortable with. If you need time to think it over, then take the time. If an agent tells you he or she is not comfortable selling you the term insurance you need because they feel you are making a mistake, thank them for their time and escort them to the door. As you approach the door and they have a sudden change of mind, keep walking, you need to find an agent you can trust. As I said earlier, be prepared. Do your research, perform a web search on the term “overcoming life insurance objections”. The search results will provide you with the road map the agent is going to use to get you to act in the way he or she desires. Be prepared.
Selecting a company
You can search for life insurance companies online, and it is one of the most convenient ways to purchase life insurance. But one thing you need to pay close attention to is the insurance company's rating. A company by the name of A.M. Best rates insurance companies based on their financial strength, stability and ability to pay. The ratings range from A++ to F. I would not recommend going below a rating of A-. Remember, this is for A.M. Best, there are other rating agencies with different rating scales. For example, an A- on the Standard and Poor’s rating scale is one level lower than the A- on the A.M. Best scale. So look for the A.M. Best rating.
Some parting humor
After a long discussion between the customer and the life insurance agent concerning the various life insurance policies, the customer asks the agent, “So you are saying if I purchase this policy, I will have the money to send my children to college?”. The agent answers, “No, you must have misunderstood, I said if you buy this policy I will have the money to send my children to college”.