Continuing the Conversation on Life Insurance

What type of life insurance to buy?

Now that we know when to buy, what type of policy should we purchase. Using the previous example, the family above is burdened with debt in their early years. As time goes by, this debt is paid off as salaries increase and saving is accumulated. Once their debt is paid off with a sizable savings, there is no further need for life insurance. This time frame is usually over a 20 to 30 year period. As a result, this family may have bought a “Term Life Insurance Policy” in the early years of the family. A Term Life Insurance Policy is issued for a period of time called a “Term” and cost less than a permanent policy. A Term Life Insurance Policy is usually issued as annual renewable term, five, ten, fifteen, twenty, twenty-five or thirty year term. After the term is over, one has the option to purchase this policy at a much higher price as permanent insurance or just let it expire. Assuming their debts are paid off, at the end of the term, this family can rely on their savings and investments for burial expenses.
On the other hand, this family may want a permanent life insurance policy that will outlast the owner and be able to accumulate value while paying premiums. Unlike Term Life Insurance, Whole Life or Universal Life Insurance is permanent. These policies are typically more expensive but give a guaranteed rate of return and expire well beyond the average life expectancy of the owner. In many cases, these policies last until 125 years of age. This family will not have to worry about the expiration of their policy and will likely have an accumulated savings after owning the policy over a long period of time.

How much to purchase?

Option (1)
Calculate your liabilities such as the money owned on your Mortgage, Student Loans and Credit Card Depts. Total this number and use it as your Face Value for your Life Insurance Policy. It may be best to use this method if the beneficiary has a steady livable income, and will not have to depend on the proceeds of the policy for daily expenses.

Option (2)
Compute what income would be lost if one of the bread winners were to die. Take this amount and divide it by an annual return or yield that you and your spouse are comfortable with purchasing. i.e. One bread winner brings home $50K/Year, so divide this number by the interest rate or return given on your investment portfolio. $50K/.05 = $1,000,000. One Million dollars becomes the Face Value of your policy. This means if a loved one making $50K/Year dies, putting the face amount into an interest bearing account of 5% would return $50,000 a year for life. This would become an annuity giving the beneficiary a $50K income for life.

Option (3)
If you cannot afford the other two options, then buy time. After the passing of a loved one, people need time to adjust to their loss. Let’s say your monthly debt is $2500/month. By purchasing a $100,000 life insurance policy, you have just bought yourself 40 months of time ($100K/$2500/month = 40 months). Use the money to pay your monthly bills and use the time to find another job, relocate, etc.