Determining Your Life Insurance Needs

What role, if any, should life insurance play in your financial plan depends on a variety of factors, such as your marital status, dependents, worth and estate planning goals.

Assessing Your Situation

Life insurance is an important factor in achieving your financial goals and protecting your assets. If others depend on you financially, your number one priority is likely ensuring that they will continue to be provided for after you’re gone.

If you’re single and have no dependents, life insurance may not even be necessary. However, you may want enough coverage so that your mortgage can be paid off and your home can pass unencumbered to your designated heirs. You may also consider getting a policy to cover your funeral expenses.

If your net worth is substantial and can meet such needs, life insurance should still be considered as it may prove beneficial in the implementation of your estate plan. For example, it can provide liquidity to pay estate taxes without having your beneficiaries sell assets that you want to keep in the family. It can also be used if you are the owner of a family run business. Sufficient proceeds from the insurance can be directed to those family members who will not receive an ownership in the company in order to equalize inheritances.

Calculating the Coverage

If you determine that you need life insurance, the next step is calculating how much coverage you need.

If the coverage is to replace income and support your family, you will need to calculate the costs that need to be covered, such as housing and transportation, child care and education — and for how long. For some families, this may continue until the last child is financially independent.

Next, you will need to identify income available to your family, such as social security, investments, and retirement savings. Insurance can help bridge any gap between the expenses to be covered and the income available.

If you’re purchasing life insurance for another reason, the purpose will dictate how much you need:

Funeral costs. An average funeral bill can reach $7,000. Gravesite costs typically add thousands more to this number.

Mortgage payoff. You’ll need coverage equal to the amount of your outstanding mortgage balance.

Estate planning. If the goal is to pay estate taxes, you’ll need to estimate your estate tax liability. If it’s to equalize inheritances, you’ll need to estimate the value of business interests apportioned to each child active in your business, and purchase enough coverage to provide equal inheritances to those children unaffiliated with the business.

You should also keep in mind how taxes factor in. See the sidebar “The Tax Impact of Life Insurance.”

Term vs. Whole Life Insurance

The next question is what type of policy to purchase. Life insurance policies generally fall into two broad categories: term or whole life (permanent).

Term insurance is for a specific period of time.  Should you decease during the policy’s term, it pays benefits to the named beneficiaries.  Should you outlive the term, no benefits are paid.  Term insurance is typically much less expensive than permanent life insurance, especially if purchased while you’re relatively young and in good health.

Permanent life insurance policies continue until you die, so long as you’ve paid the premiums. Most permanent policies build up a cash value that you may be able to borrow against or use to pay the premiums.

Because the premiums are typically higher for permanent insurance, you need to consider whether the additional cost is worth the benefit. For example, if the need for insurance dwindles as you get older because you no longer need to provide for your children, then term insurance may be a wiser investment.

Permanent life insurance may be advisable if you’re concerned that you could become uninsurable in the future, if you’re providing for special-needs children who will require continued financial support, or if the coverage is to pay estate taxes or equalize inheritances.

Fulfilling Your Goals

While no one likes to think about leaving loved ones behind, most people find some comfort in knowing their family’s financial needs will be covered and their estate planning goal will be fulfilled. A suitable life insurance policy can help.

Sidebar: The Tax Impact of Life Insurance

While proceeds are generally income tax free to the beneficiary, they will be included in your taxable estate as long as you are the owner of the policy. If your taxable estate exceeds the estate tax exemption ($5.45 million for 2016), the life insurance proceeds could be subject to estate taxes. To avoid this, consider having someone else own the policy, or set up a life insurance trust. You need to be careful when changing the ownership of the policies because it may create other tax and financial complications. Therefore, it is important to consult your tax and financial advisors before any decisions are made.

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