How Much Life Insurance Do You Need?

Life insurance is a contract between an insurance company and a policy owner, where the insurer agrees to pay a sum of money to the beneficiaries when the insured person dies. The amount of money paid out is called a death benefit. The policyholder must pay a premium for the life insurance policy to remain in force. The death benefit is usually tax-free, and can be used to cover funeral expenses, pay off remaining debts, and fund retirement.

There are two main types of life insurance: permanent and term. Permanent life insurance policies do not have an expiration date, meaning you are covered for life as long as your premiums are paid. Term life insurance, on the other hand, only covers you for a set number of years and does not accumulate cash value.

The amount of life insurance coverage you need depends on various factors, including your age, income, financial goals, family situation, and number of dependents. A common rule of thumb is to get coverage that is 10 times your annual income, but this may vary depending on your specific circumstances.

Life insurance for stay-at-home parents

Life insurance is often thought of as a necessity for the primary earner in a household, but it is also important for stay-at-home parents to have coverage. Stay-at-home parents provide significant financial value to their families, and their contributions should be considered when planning for the future.

The services provided by stay-at-home parents would be costly to replace. These include childcare, household management, meal preparation, and housekeeping. The cost of childcare alone can be extremely high, with expenses soaring up to $36,000 per year, per child. In addition, stay-at-home parents spend an average of seven hours a week on chores, 120 minutes on laundry, up to eight hours on cooking, and around six hours driving. If something were to happen to the stay-at-home parent, the surviving spouse would have to cover these tasks, on top of working full-time.

A life insurance policy for a stay-at-home parent can provide the money needed to cover the roles they played before their passing. The surviving spouse could hire people to fill in the gaps, at least temporarily, ensuring that the family can continue to function.

When deciding on the amount of coverage, there are several factors to consider:

• Family size: Larger families have larger financial needs, including childcare, groceries, vacations, and extracurricular activities.
• Career plans: If the stay-at-home parent plans to return to work, it is a good idea to get them life insurance sooner rather than later, locking in a lower rate.
• Childcare: Consider the cost of childcare in your area, and how many children you have.
• Education: If your children are homeschooled, or you plan to send them to private school, factor in these costs.
• Household duties: Calculate the cost of hiring someone to clean the house and perform other household tasks.

A general rule of thumb is to get a 15- to 20-year policy of at least $250,000–400,000. However, every family is different, and it is important to assess your unique situation and needs.

In addition to term life insurance, there are other types of life insurance that can serve multiple purposes. Fixed Indexed Universal Life (FIUL) products, for example, provide coverage in the case of an unexpected death and may include benefits such as living benefits or coverage for critical, chronic, or terminal illness. These benefits can help cover the costs of illness or provide opportunities for retirement savings outside of an employer plan.

To determine the right level of coverage, it is recommended to work with a financial professional or insurance agent, who can help you assess your needs and circumstances.

Mortgage protection

The main benefit of mortgage protection insurance is that it can save beneficiaries a lot of money each month and give them access to more equity in the home. Mortgage protection insurance policies also generally don't require a medical exam, making them more accessible to those who don't want to take medical exams for life insurance or want to get covered quickly. Riders can also be added to mortgage protection policies, allowing for customisation to suit individual needs. For example, a waiver of premium rider can help cover premiums if the policyholder becomes disabled and unable to work.

However, there are some drawbacks to mortgage protection insurance. The death benefit is paid directly to the mortgage lender, meaning beneficiaries cannot use the benefit to help pay off other debts or expenses. The payout also decreases over time as the mortgage is paid off, and premiums remain the same, meaning the cost per dollar of coverage increases over time. Mortgage protection insurance can also be expensive for the level of coverage received.

Children's college funding

The cost of college is rising, with tuition fees increasing by 2% annually over the past decade. This has made a college education unaffordable for many families, and student loan debt has reached unprecedented levels. As such, it is important to start financial planning for your child's future education as early as possible.

There are many ways to save for your child's education, and choosing the right life insurance policy can be a great way to supplement your savings. Permanent life insurance, which has a tax-deferred savings component, is one way to do this. This type of insurance is incredibly flexible compared to other policies, as it provides coverage for your entire life and includes a savings or investment account that builds cash value over time. This cash value can be used to pay for college expenses, and permanent life insurance policies offer several benefits in this regard:

• Flexibility: If your child doesn't attend college, you won't face the same tax penalties as you would with a 529 plan. The money can also be transferred to another beneficiary or, in some cases, withdrawn for other purposes.
• Guaranteed payment: Any cash value accumulated must be paid by the insurance company.
• Tax advantages: Cash value account growth is tax-deferred, loans taken from the account are tax-free, and you only pay taxes on withdrawals when they exceed the amount you paid in premiums.
• Financial aid advantages: Cash value accounts are excluded from college financial aid calculations, giving your child the opportunity to receive additional aid.

However, there are also some disadvantages to using permanent life insurance to save for your child's education. These include high premiums and annual fees, long wait times for the cash value account to grow, and a higher tax impact if you withdraw more money than you've paid in premiums.

Another option for saving for your child's college education is a 529 plan, which allows tax-deferred saving with tax-free withdrawals. However, it counts as an asset when you apply for financial aid, and the money must be used for qualifying educational expenses.

In conclusion, permanent life insurance can be a useful tool for saving for your child's college education, but it is important to carefully consider the pros and cons before deciding if it is the right choice for your family.

Funding a buy-sell agreement

A buy-sell agreement is a legally binding contract between the owners of a business that usually provides for the sale of an ownership interest upon certain events such as death, disability or retirement. It is one of the most important elements in the planning for any business's long-term success, especially in the case of family-owned businesses.

There are two common life insurance arrangements when funding a buy-sell agreement: cross-purchase and entity-owned.

Cross-Purchase Arrangements

In cross-purchase arrangements, every owner personally owns a life insurance policy on one another and is the beneficiary of that policy. For instance, in a business with two owners, A purchases a policy on B, and B purchases a policy on A. However, this arrangement becomes more complicated with the addition of more owners. If a third owner, C, is introduced, six policies are now required.

Entity-Owned Arrangements

The alternative is for the business itself to be the owner and beneficiary of life insurance policies on each owner. This reduces the number of policies to one for each owner. When an owner dies, the business receives the death benefit, funding the purchase of the deceased's shares, and distributing the interests across the remaining owners.

Advantages of Using Life Insurance to Fund a Buy-Sell Agreement

• Life insurance creates a lump sum of cash to fund the buy-sell agreement at death.
• Life insurance proceeds are usually paid quickly after death, ensuring the transaction can be settled swiftly.
• Life insurance proceeds are generally income-tax-free.
• If permanent life insurance is used to fund the agreement, and sufficient cash values have built up within the policies, the funds can be accessed to purchase the business interest following an owner's retirement or disability.
• It ensures the business will have the means to purchase an exiting owner's shares, regardless of timing.
• If a partner passes away shortly after an agreement is drafted, the total premium paid to date will be much less than the death benefit received.

Disadvantages of Using Life Insurance to Fund a Buy-Sell Agreement

• The feasibility of this funding mechanism is dependent on the insurability of the owners.
• It may not be suitable for every business or owner. Each owner should carefully analyse their desired goals to determine the appropriate funding method.

Key person protection for a business

Key person insurance is a type of life insurance policy that a company purchases for an owner, top executive, or another employee considered critical to the business. The company pays the premiums and is the beneficiary of the policy. This type of insurance is also known as "key man" or "key woman" insurance.

Key person insurance is needed if the death of the insured would be devastating to the future of the company. For small businesses, this is often the owner or founder, but it could also be someone with a highly specialized role or someone responsible for a large share of sales.

The death benefit from key person insurance can be used to:

• Cover the costs of recruiting, hiring, and training a replacement for the deceased.
• Pay off debts, distribute money to investors, provide severance benefits to employees, and close the business in an orderly manner.
• Protect heirs from having to pay off company debts.
• In a partnership, buy out a deceased partner's shares from their family members.
• Offset lost income from lost sales or losses resulting from the delay or cancellation of any business project involving a key person.
• Enable surviving shareholders or partners to purchase the financial interests of the deceased person.
• Protect anyone involved in guaranteeing business loans or banking facilities.

The amount of key person insurance needed will depend on the business and the type of role the key person plays. It is often recommended to purchase insurance that is eight to ten times the key person's salary or the monetary value of the key person.

When deciding between term or permanent insurance, it is important to consider what makes the most sense for the business. Term insurance is more affordable, but coverage is temporary and premiums will be higher if the policy needs to be renewed. Permanent insurance has higher premiums but can provide additional benefits, such as building cash value that the business can borrow against or withdraw from for future expenses.

Frequently asked questions