Contrary to what an insurance salesperson may tell you, not everyone needs life insurance. So who does need life insurance and when should you buy it? In general terms: some single people may need life insurance, individuals or couples with young children almost always need life insurance for a period of time, and as people age, the need for life insurance typically declines. Before moving onto a more detailed discussion, it is important to note that as independent, fee-only financial advisory firm, we do not sell life insurance and have no financial affiliation with any company who does. We routinely advise our clients on insurance-related issues as part of our wealth management services.
What is life insurance used for?
To understand who needs life insurance, it is helpful to first explain how life insurance is typically used. Here are some of the main reasons people purchase life insurance:
- Pay off debt: Depending on a number of factors (e.g. the type of debt, titling, presence of a co-signer, etc.) debt may be forgiven when you pass, paid from your estate, or need to be paid off from outside sources. A mortgage, student loans, and credit card debt are common examples.
- End of life expenses: Funeral and burial expenses average between $7,000 - $10,000. For some families, this sudden cost cannot easily be absorbed out of pocket.
- Income replacement: Couples and families build their lifestyle around their current and projected income. Allowing the family to remain in the home by paying off the mortgage or funding college savings accounts may be important. The need for life insurance is greater in one-income households or when one spouse earns significantly more than the other.
- Other costs: Life insurance is also used to cover new expenses that may arise from the death of a nonworking partner. Although a stay at home spouse may not earn any income, they may also eliminate the need for outside child care, elder care, housekeeping, and so on.
Who needs life insurance?
There is no clear rule for who does and does not need life insurance as it will depend on your financial and personal situation, as well as your personal preferences. In all of these situations, consider your wishes after you passed and the needs of your family. For example, would your partner want to sell the house or pay off the mortgage and remain in the home? What changes would you expect in their living expenses and lifestyle? What about other goals, such as paying for college? The following examples provide broad guidance which you can consider to help determine whether you may need life insurance:
- Single person - Most single people do not need life insurance. However, as mentioned earlier, individuals with certain types of debt may wish to consider purchasing life insurance. For example, if you have private student loans with a co-signer, that individual may become responsible for paying off the debt. Similarly, if you own a home with someone else, they may become responsible for carrying the mortgage alone depending on how the asset was titled. While private life insurance may not be necessary for an unmarried individual without children, life insurance offered by an employer may be given as an employee benefit or available for you to buy at a discounted rate. For some, the nominal expense may be worth the additional piece of mind. Continue reading for more information on getting life insurance through an employer.
- Married couple without children - Married couples without children typically need at least some life insurance. In this situation, the main needs are typically debt payment and lifestyle support. If one spouse does not work, they may not need life insurance coverage and may not even be able to get it. If you are planning a family, it may be advantageous to get life insurance while you're younger, with the future family in mind. Continue reading for more on when you should buy life insurance.
- Married couple with dependent children - Married couples with young or dependent children almost always need life insurance. Unless you've amassed a fortune which can be accessed by your family in the instance of your death, chances are life insurance coverage is appropriate. Exactly how much insurance you may need will depend on your wishes and your family's needs. In the case of a nonworking parent, insurance should be considered to cover child care and other new expenses.
- Unmarried couple with dependent children - Unmarried individuals with dependent children should strongly consider life insurance also. Depending on your relationship your future financial needs and lifestyle may differ from a married couple, but it is still important to ensure the children are provided for in the event of your premature death. Depending on the situation, it may be appropriate to name the child or another individual as the beneficiary to ensure the funds are spent appropriately.
- Single parent - A single parent of a dependent child will certainly need life insurance. Naming a beneficiary may require some thought, but steps can be taken to help ensure the child receives the proceeds and they are spent appropriately. Although a separate issue, it is especially important for single parents to have a legal guardian named in case something happens to you.
- Divorced individual receiving child support - If you are receiving child support or maintenance payments from an ex-spouse and they die, future payments will stop unless other arrangements have been made. Although a divorce decree may stipulate that a life insurance policy is maintained with the children or ex-spouse as beneficiaries, sometimes little can be done to ensure premiums are actually paid. Consider taking out your own life insurance policy on your ex-spouse.
- Married couple with adult children - A married couple with independent adult children may not need life insurance. Typically, once the kids are out of college and the mortgage paid off, the need for life insurance declines. At this stage of life many adults have already contributed a significant amount to their retirement accounts and there may be other sources of income as well. At retirement, there is often little need for life insurance as there is no income stream to replace.
When should you get life insurance?
Before you need it! Obviously you need to buy life insurance before you die, but it may be advantageous to get life insurance in anticipation of a life event - not after it happens. For example, anyone planning a family in the next few years may wish to purchase life insurance now. Why purchase insurance early? For a few reasons actually:
- You are decidedly younger today than you will be in a few years and all else equal, the younger you are, the cheaper the insurance will be
- Don't take advantage of your good health - you never know what can happen even a year from now. If you wait and something changes with your health, you may not be able to get insurance coverage at all
- People procrastinate! Buying life insurance is not fun - nothing about estate planning is. But that doesn't make it any less important. Get this out of the way before your life gets even crazier
What type of life insurance should you buy?
There is no one best type of life insurance that will suit every situation. Policies have become increasingly flexible with different riders and options that you can add to customize your plan. When shopping for life insurance, work with an independent agent and understand how they are compensated. Ask about fees, expenses, surrender term and charges, and the track record of the life insurance company itself. After all, you want to make sure the company is still in business decades later should you or a loved one need to file a claim.
How much insurance do you need?
How much life insurance coverage you need will depend on your wishes and family's income needs and expected lifestyle in the future. If you're working with a financial advisor, they can help you with this calculation. Families with high incomes typically have an expensive lifestyle, which may easily require several million dollars in life insurance to support. For our clients, as part of a financial plan, we will actually model out projected needs based on current spending, future goals, lifestyle adjustments, inflation, and other income or expense items for a much more accurate figure.