Research shows that many of us tend to insure what we own, but pay little attention to insuring our most important asset: our ability to earn income. Life insurance alone is not the answer since statistics show that a 35-year-old is about four times more likely to experience a period of disability than to die before reaching retirement age.
Many are surprised to learn that Social Security disability insurance is insufficient to support their current lifestyles, or that a surprisingly high number of initial claims for benefits are denied. If your claim is approved, Social Security will typically replace 20 to 50% of earnings. The definition of disability is also fairly stringent: You must be totally disabled, i.e., you must have a physical or mental impairment that is expected to keep you from doing any "substantial" work for at least one year, or have a condition that is expected to result in your death. No benefits are payable under Social Security for partial disability or for short-term disability.
Now that you are expanding your family, you should make sure you have enough disability coverage through your employer or you should purchase a personal disability policy that will allow your family to maintain their current standard of living in the event of your disability.
What would happen to your family if you or your spouse were to die? Who would provide for your family's financial needs?
Life insurance should always be in place to provide for immediate final expenses, such as unpaid medical bills, funeral expenses, and estate settlement costs. It should also meet the day-to-day costs of running a household. Thus, life insurance covers the loss of the income earner's income stream. This is sometimes referred to as "human value." You can have confidence knowing that the mortgage, utility bills, and taxes will all be taken care of in case of your death. Besides daily financial needs, life insurance can provide for another measure of safety: assuring that your family's long-range financial goals are met, such as retirement income or college funding.
When exploring life insurance options, you have two basic questions, how much to buy and what type to buy.
To determine how much life insurance is needed, you need to look at your immediate cash requirements at death, how much you will need to replace lost income, and for how long, as well as providing for other long-term goals, such as college and debt retirement (e.g., paying off your home mortgage). You can reduce the amount you need by the liquid assets you have available at death, such as checking, savings, and money market accounts. The amount you specifically need depends on many individual variables. For example, an individual with many dependants should consider a life insurance policy that is large enough to cover them all. Someone with few dependants may not need as much coverage. When you consider what's right for you, consider what your family's expected expenses will be, the amount of time you need coverage for those expenses, and future goals such as college funding, retirement funding, and debt retirement.
What type of life insurance do you buy?
Although many policies exist, there are two main types of life insurance: term and permanent. The best one for you depends on your personal situation.
Term: This type offers a large death benefit with a relatively low premium compared to a permanent policy. However, these premiums go up as you age or when the policy is renewed. Term policies function as a safety net for your family, not as an investment. They do not accumulate cash value or contain a savings component. They are sometimes referred to as "pure" insurance. There are three key features to look for when purchasing term insurance:
1. Is the premium guaranteed, and, if so, for how long?
2. Is the coverage renewable without proof of insurability, and, if so, for how long?
3. Can the policy be converted into permanent insurance, without proof of insurability, and if so, for how long?
Permanent: These cash value policies have higher premiums that are generally intended to remain level throughout your life. While their primary objective is to provide your beneficiary with a death benefit, they also function as a form of savings. Traditional "whole life" policies have fixed premiums and provide guaranteed yearly increases in cash value. Some even pay dividends, which increase your total savings. Non-traditional policies—universal and variable life—are more flexible and accumulate cash based on current interest rates or underlying investments which you choose.
Once you put together the numbers, you'll often find that the coverage you require is a very high amount. A young family with a newborn may be able to afford only term insurance in order to get the coverage they need.
Considering Beneficiary Designations
If you're covered by a life insurance policy, contribute to your 401(k) plan, have an IRA, or participate in a deferred compensation plan, you know that these plans ask you to name beneficiaries in the event of your death. At the moment, it is likely that your spouse, parents, or some other family member(s) are listed as your primary beneficiary. Now that you have a new child, you should review your named beneficiaries to make sure that the list is still appropriate. At a minimum, you may want to add your new family member to your list of contingent beneficiaries. If the intended beneficiary is too young, the beneficiary of the proceeds could be a trust established under your will for the benefit of the individual beneficiary. A contingent beneficiary is a secondary beneficiary, paid only after the death of your primary beneficiary. It is not something we like to think about, this business of death and beneficiaries, but it is another important element in your financial planning and in properly providing for the security of your loved ones.
Caution: Life insurance is a complicated and critical element to your planning. Consult with a financial professional when determining how much and what type of coverage you need.
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