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Retirement, investments, financial planning for every stage of life—learn about it all here at Invested,
a blog from your Wealth Management Advisors at Kirtland Financial Services.

Do You Need Life Insurance? How To Decide

07/27/2020
Kirtland Financial Services

Do you carry a life insurance policy? What type is it? Do you have enough insurance for your situation? The insurance you choose can have a big impact on your financial planning. Here are some factors to consider when evaluating different life insurance options.

There are two basic types of life insurance: term life and permanent (cash value) life. For a rundown of these two types and their key differences, click here. 

Do you need life insurance?
At some point in your life, you'll probably be faced with the question of whether you need life insurance. Life insurance is a way to protect your loved ones financially after you die and your income stops. The answer to whether you need life insurance depends on your personal and financial circumstances.

You should probably consider buying life insurance if any one of the following is true:
  • You are married and your spouse depends on your income
  • You have children
  • You have an aging parent or disabled relative who depends on you for support
  • Your retirement savings and pension won't be enough for your spouse to live on
  • You have a large estate and expect to owe estate taxes
  • You own a business, especially if you have a partner
  • You have a substantial joint financial obligation such as a personal loan for which another person would be legally responsible after your death
In all of these cases, the proceeds from a life insurance policy can help your loved ones continue to manage financially during the difficult weeks, months, and years after your death. The proceeds can also be used to meet funeral and other final expenses, which can run into thousands of dollars.

If you're still unsure about whether you should buy life insurance, a good question to ask yourself is:

If I died today with no life insurance, would my family need to make substantial financial sacrifices and give up the lifestyle to which they've become accustomed in order to meet their financial obligations (e.g., car payments, mortgage, college tuition)?

If the answer is yes, insurance is something to seriously consider. And once you decide you need life insurance, don't put off buying it. Although no one wants to think about and plan for his or her own death, you don't want to make the mistake of waiting until it's too late.

How much life insurance do you need?
Your life insurance needs will depend on a number of factors, including the size of your family, the nature of your financial obligations, your career stage, and your goals. For example, when you're young, you may not have a great need for life insurance. However, as you take on more responsibilities and your family grows, your need for life insurance increases.

Here are some questions that can help you start thinking about the amount of life insurance you need:
  • What immediate financial expenses (e.g., debt repayment, funeral expenses) would your family face upon your death?
  • How much of your salary is devoted to current expenses and future needs?
  • How long would your dependents need support if you were to die tomorrow?
  • How much money would you want to leave for special situations upon your death, such as funding your children's education, gifts to charities, or an inheritance for your children?
  • What other assets or insurance policies do you have?
Estimating your life insurance need
There are a couple of simple methods that you can use to estimate your life insurance need. These calculations are sometimes referred to as rules of thumb and can be used as a basis for your discussions with your insurance professional.

Income rule
The most basic rule of thumb is the income rule, which states that your insurance need would be equal to six or eight times your gross annual income. For example, a person earning a gross annual income of $60,000 should have between $360,000 (6 x $60,000) and $480,000 (8 x $60,000) in life insurance coverage.

Income plus expenses
This rule considers your insurance need to be equal to five times your gross annual income plus the total of any mortgage, personal debt, final expenses, and special funding needs (e.g., college). For example, assume that you earn a gross annual income of $60,000 and have expenses that total $160,000. Your insurance need would be equal to $460,000 ($60,000 x 5 +$160,000).

Several more comprehensive methods are used to calculate life insurance need. Overall, these methods are more detailed than the rules of thumb and provide a more complete view of your insurance needs.

Family needs approach
The family needs approach requires you to purchase enough life insurance to allow your family to meet its various expenses in the event of your death. Under the family needs approach, you divide your family's needs into three main categories:
  • Immediate needs at death (cash needed for funeral and other expenses)
  • Ongoing needs (income needed to maintain your family's lifestyle)
  • Special funding needs (college funding, bequests to charity and children, etc.)
Once you determine the total amount of your family's needs, you purchase enough life insurance, taking into consideration the interest that the life insurance proceeds will earn over time, to cover that amount.

Income replacement calculation
The income replacement calculation is based on the theory that the family income earners should buy enough life insurance to replace the loss of income due to an untimely death. Under this approach, the amount of life insurance you should purchase is based on the value of the income that you can expect to earn during your lifetime, taking into account such factors as inflation and anticipated salary increases, as well as the interest that the lump-sum life insurance proceeds will generate.

Estate preservation and liquidity needs approach
The estate preservation and liquidity needs approach attempts to calculate the amount of life insurance needed upon your death to settle your estate. This includes estate taxes, and funeral, legal, and accounting expenses. The purpose is to preserve the value of your estate at the level prior to your death and to prevent an unwanted sale of assets to pay estate taxes. This method takes into consideration the amount of life insurance needed to maintain the current value of your estate for your family, while providing the cash needed to cover death expenses and taxes.

Periodically review your coverage
Once you purchase a life insurance policy, make sure to periodically review your coverage—especially when you have a significant life event (e.g., birth of a child, death of a family member)—and make sure that it adequately meets your insurance needs. The most common mistake that people make is to be underinsured. For example, if a portion of your life insurance proceeds are to be earmarked for your child's college education, the more children you have, the more life insurance you'll need. But it's also possible to be overinsured, and that's a mistake, too—the extra money you spend on premiums could be used for other things.

The team at Kirtland Financial Services does not sell insurance but can help you evaluate your options and see where and how a life insurance plan fits into your overall financial planning picture. Talk to a Wealth Management Advisor for free!

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Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. The information provided is not intended to be a substitute for specific individualized tax planning or legal advice. We suggest that you consult with a qualified tax or legal professional. Material prepared by Broadridge Investor Solutions, Inc. for Kirtland Financial Services.
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