Life insurance is one of my favorite insurance products to sell.
Why? Because it’s a selfless investment you make in the ones you love so they can continue their lives after you’re gone without a financial hardship.
Financial relief helps survivors to focus on recovering from the emotional hardship of losing someone they love. Life insurance is about leveraging a small sum of money (the premium) in exchange for a lump sum of money (death benefit).
Yes, “death benefit” may be an oxymoron but it is for the benefit of your loves ones in the event of your death. It’s also about liquidity: by purchasing life insurance, you’re ensuring that your family doesn’t have to liquidate a profitable asset just to be able to pay the bills.
Why buy term life insurance?
Term life insurance will give your family financial liquidity to cover a myriad of expenses including:
- Funeral or end-of-life ceremony
- Uncovered medical expenses
- Any estate taxes owed
- Lump sum debt obligations
- Final estate settlement expenses
- Ongoing business expenses
- Ongoing household expenses
How much term life insurance should you buy?
But perhaps the most important thing term life insurance can do is to provide an income stream that the survivors can live on after your death. How much term life insurance should you buy?
Consider how much the household needs to earn to maintain the standard of living to which they are accustomed. Add up the financial obligations, such as a mortgage, insurance premiums, auto loan, credit card debts, college tuition and other expenses for which they are responsible.
Next, deduct existing resources such as investments that generate an income (or can be sold or reinvested to generate cash flow), insurance benefits, any Social Security or pension payments and income the surviving spouse would should he or she decide to continue working.
Let’s say a family spends $6,000 per month (excluding taxes) on the mortgage, household expenses, insurance premiums, auto loans and other costs of living. Let’s say there are also 2 children who will go through college in a few years, which would cost anywhere from $25,000 to $50,000 per year or $100,000 to $200,000 per child.
Now, let’s assume that the decedent’s pension, Social Security payments and other investments will generate $3,000 per month. That leaves $36,000 per year of expenses that need to be paid. You’d need to have about $800,000 in the bank to generate $36,000 of income at 5 percent. You’ll need more if you’re only getting 3 percent annual rate of return.
Add the $200,000 to $400,000 needed to get the kids through college (admittedly, it might cost less and there might be scholarships, but term life insurance is about protecting someone in the worst case scenario), and you’d probably want to have a policy for $1 million to $1.5 million.
Buying term life insurance
I’m often asked, “How do I get a good deal?” The reality is that if you’re in good health, you’ll be able to buy a relatively cheap term life insurance policy.
The primary pricing factors for a term life policy are your health (including whether you smoke) and your age. Underwriting guidelines and actuarial tables evaluate every aspect of a person’s health and how it contributes to life expectancy. The healthier you are, the lower the premium.
If you’re not in great health, you can still get a good policy at a relatively reasonable rate by disclosing upfront to your agent, prior to the application phase, all medical conditions, including height and weight, medications, diseases, disorders, surgeries and treatments. Then, have your insurance agent vet the various carriers to see how you would be approved and rated, and to determine a possible premium.
By running these conditions through the gauntlet before you apply for the policy can prevent you from having your application turned down. [edited: 6/17/2010] The Medical Insurance Bureau (MIB) keeps track of previous applications, and the records can be accessed by insurance underwriters. Any false, or omitted, information on your application can be easily revealed.
Remember, your policy approval is tentative until the application is submitted, an exam is conducted and medical records are released for review. Sometimes it’s best to apply to more than one carrier. Some carriers are more lenient and flexible with different health conditions.
Working with a trusted insurance advisor will facilitate a cash flow analysis that provides a snapshot of the household’s financial status to determine how much life insurance you really need.
You can also use a comprehensive online calculator tool to help you become familiar with the aspects of how you currently function financially, and determine future obligations.
Remember, it’s not about how much term life insurance you need to buy. It’s how much money your loved ones need to live after you’re gone.
Linda Rey is a licensed insurance agent at Rey Insurance with a broad spectrum of expertise in life, accident, health, property, and casualty insurance, as well as retirement planning and college funding strategies. Follow her on Twitter: @ReyInsurance