Assess Your Life Insurance
One of the most uncertain times for a family can be after the unexpected
death of a loved one — especially someone the family depended on for
financial support. Reviewing your life insurance coverage can help ensure
your loved ones are protected if something happens to you.
Calculate Needed Coverage
Two simple methods to estimating your life insurance needs are the income
replacement approach and the needs approach.
Income replacement approach
The income replacement approach to estimating life insurance needs has you
predict how much you’ll earn from now until you retire. Here’s the formula:
Life insurance needs = annual income * years until retirement
For example, suppose Gail is 35 years old and plans on retiring in 30 years
at age 65. She currently earns $65,000 per year. Gail’s life insurance needs =
$1,950,000 (or $65,000 * 30).
Although the income replacement approach is great for a rough estimate, it
doesn’t account for raises you may receive or for inflation.
Needs approach
The needs approach, which takes into account the short- and long-term
needs of your beneficiaries, is more accurate than the income replacement
approach and is the method used by most professionals. Here’s the formula:
Life insurance needs = money required for short- and long-term needs –
available financial resources
When using this approach, be as accurate as possible. Inflation will affect the
future value of your beneficiaries’ needs. Consider contacting a fee-only advisor
if you want help using the needs approach.
Compare Current Life Insurance
Coverage to Your Calculated Need
After you know how much life insurance coverage you need, compare that
amount to your current coverage. If you’re currently underinsured, you have
two options:
- Replace your current life insurance policy (or policies) with a single
policy. Most life insurance policies offer breakpoints (discounts) when
you purchase large amounts of coverage, usually making it less expensive
to have one large policy rather than several small ones.
- Buy an additional policy. The cost of insurance increases as you age,
so in some cases, purchasing an additional policy may be less expensive
than replacing an old policy.
If you discover you have too much coverage, consider the following:
- Think about your future needs. If you foresee new kids, debts, or big
raises on the horizon, or if your health has changed, you may want to
hang on to what you have.
- If you’re sure you don’t need all your life insurance, you can usually
reduce or simply cancel a policy. If you have a term policy, contact the
agent about reducing the coverage or just stop paying the premium.
If you do need part of the coverage, compare the cost of the reduced
policy to your options on the market.
- If you have a permanent policy — either whole life or universal life
— ask your agent for the net surrender value. This is the amount of
your cash value that you get to keep after surrender charges. If you’re
reducing coverage, there may still be a charge to your cash value, even
though you’re keeping the policy. You may find that you’re better off
keeping the policy, at least until the surrender charges no longer apply.
If you decide to replace an existing life insurance policy, never cancel your
existing policy until you’ve obtained replacement insurance. Additionally,
each state requires disclosure forms to anyone replacing existing life insurance,
so read them carefully.
Pick the Right Type of Life Insurance
for Your Situation
There are two types of life insurance policies: term and permanent. Think term
for a temporary need and permanent for needs that’ll last for your lifetime.
Term life insurance
Term life insurance covers a certain period of time, typically 10, 15, 20, or 30
years. Consider matching the term of the policy to specific milestones, such
as when children leave home, when college is paid for, or when you retire.
You pay for the policy for the entire period. At the end of the term, the policy
expires, just like auto or homeowner’s insurance. (For a higher premium,
some term policies will return all premiums paid if no benefits are paid
during the entire term.)
Term coverage costs less than permanent because it’s temporary and very
few policies actually result in claims (that is, most are cancelled or expire).
The lower cost of term insurance makes it a great choice if you have a limited
budget and need a lot of coverage, but you don’t need permanent coverage.
Because term insurance expires, you may want a policy that allows you to
renew the policy for an additional term or to switch to a permanent policy
before the policy terminates:
- Renewable term insurance allows you to renew the policy at the end of
the term without providing proof of insurability, although the premiums
will increase because you’ll be renewing at a higher age.
- Non-renewable term insurance is less expensive than renewable term
insurance because it automatically expires at the end of the term.
- Convertible term insurance allows you to convert term insurance to a
permanent policy before the end of the term. Premiums on the permanent
policy are based on your age when you convert. This is a great way
to secure low-cost coverage now and have the option to switch to a permanent
insurance later.
- Non-convertible term insurance is less expensive than convertible term
insurance because it doesn’t give you the right to convert it to a permanent
policy.
