Life Insurance 101: Because Adulting Needs a Safety Net

Going through life we run into a lot of the “less-than-pleasant” adult responsibilities that force us to grow up and take action. A lot of time these responsibilities help us mature, make us better people, and can be rewarding… other times they can be as boring as watching paint dry, like purchasing insurance… Now, don’t run away yet. I know insurance isn’t the most exciting topic on the internet, but it is one of those responsibilities that as well-prepared adults, we need to take seriously.

As we get older, we start to realize the importance of insuring the more valuable things in our life. We purchase our first car and immediately (mostly because many states require it by law) go out and purchase insurance for our new prized possession. A few years down the road we purchase our first home and start to shop through all the different insurance coverages to make sure we will always have a roof over our head. While we weigh job offers, we place substantial importance on the benefits provided by insurance coverage. Strangely however, we often neglect insuring the most vital aspect of our lives and the lives of our loved ones—our existence.

Why do we need life insurance and how do we know what is an appropriate amount? These are typical and sensible questions I receive when working with clients on planning for their future.

Let’s tackle the first one.

Life insurance serves as protection to ensure that everything we’ve worked for and the life we’ve built for ourselves, and our loved ones doesn’t crumble if something were to happen to us. Life is unpredictable, and as we age, the illusion of immortality fades, leaving us to consider how to protect the well-being of those we care about most.

This brings us to the second question: how much is needed?

The answer to this comes down to the lifestyle you have created. First, we need to consider how much money we make and how many years we would need to replace that income for our families if we did suffer an untimely demise (I know, really uplifting stuff).  This income replacement will help continue the lifestyle you have worked so hard to achieve for your family. Next, we want to look at what we owe in debt- our current mortgage(s), balances on our vehicle loans, personal loans, etc. This ensures we don’t walk away from this life and stick everyone else with the bill. Finally, we want to consider larger expenses in the future such as helping with the cost of your children’s higher education. Once you add all of those numbers up, you can subtract your current liquid assets (the money that your family would immediately have access to), and you end up with what you personally need for insurance. Luckily, we live in a world where there are a ton of online calculators that can help you find this number.

Unfortunately, finding the amount of life insurance we need isn’t the end of our journey. We still need to figure out what type of life insurance we want to purchase. Now, I know that there are a lot of different terms, riders, products and legalese when it comes to insurance, and I am going to try to give you a quick cheat sheet to help find exactly what you need.

Types of Life Insurance:

Term Life – Term life insurance is a product that allows you to essentially “rent” insurance for a period. You select the amount you need, the amount of time you want to be covered (usually 10-30 years) and you start paying your premium. Term Life will give you the most amount of insurance coverage for your dollar and is the simplest product you can purchase. The downside to Term Life is that you will never build up a cash balance. You simply pay the premiums for the period of time you selected and if you never use it, you only walk away with the peace of mind that you were covered if something would have happened to you.

Whole Life – Whole life insurance is another fairly straight forward option for life insurance but also comes with some pros and cons. In contrast to Term Life, Whole Life insurance will do exactly what it says, cover you for your entire life (as long as you keep paying those premiums). Additionally, it will build a cash value within the product that tends to have a guaranteed rate of return and a stable death benefit. This means you could always sell the product for the cash value if you wanted to down the road, or if you hold the policy for the remainder of your life, someone will receive a death benefit payout. The downside to whole life is that it is quite a bit more expensive than term life and you don’t always need life insurance as you enter the golden years.

Universal Life – Universal life is where the insurance industry starts to introduce flexibility as a tradeoff to taking some risk. These policies have a few different variations but essentially, they allow you to adjust your premiums and hold a cash value. The tradeoff for this is that your cash value is typically tied to market rates and adjusting your premiums can reduce your cash value or death benefit. This flexibility allows you to adapt your needs as life changes, while still holding on to some life insurance. What makes it tough from a planning standpoint is that the cash value and the death benefit are not guaranteed. Ultimately market interest rates and how you adjust the premiums over the life of the policy will dictate how much protection you give to your family if you were to pass.

Variable Life – Variable life is the insurance product that is for people who have a higher risk tolerance and want to tie their cash value to investment accounts. You will typically have a fixed premium and a guaranteed death benefit, but your cash value will fluctuate depending on the performance of your selected investments. I would advise you to work with a fee-only advisor if you consider these products and stay away from commission-based compensation models. One of the many downsides to these products are that they are complex and require quite a bit of maintenance to monitor your investment selections.

Now that we have the types of life insurance out of the way, let’s revisit that question of which type is right for you. I will preface this answer with the disclaimer that working with a professional who is operating in a fiduciary capacity is your best bet to making the right selection. However, for most folks, something like term insurance can be the best solution. It doesn’t hold a cash value and you may (hopefully) never use it, but it can give you and your family the most amount of coverage for a relatively small cost and for most, that small cost justifies the peace of mind that your family is taken care of.