Income Protection and Life Insurance Explained

Life insurance is most effective when it’s used to protect an income. If you think about it in that light it is relatively simple to decide how much and even what type of coverage to get – relatively being the operative word.

Do you need life insurance coverage, and if so, why?

You usually need life insurance only if you have people dependent on your income and in rare cases, your expertise. Those people could be; your spouse, your kids, your parents, your partners in business, even an ex-spouse who is depending on your help in raising your children. What all of these people have in common is that if you pass away, they would still need to deal with all of the same things they dealt with when you were there, but without the presence of you or your income.

Grief is going to be the first order of business, but soon your survivors are going to have to look at their bills and realize they have half as much income to pay them, or worse, none at all. No one wants the legacy they leave behind to lead to the loss of the family home and a slide into bankruptcy and poverty.

What type, and how much?

Now that you see the picture of what life insurance does and why it’s necessary, you really ought to find out how much you need. Remember, our goal is to replace your income, right?

• That means that the policy many of us receive through our company benefits plan – some with as little as $10,000 in coverage – won’t get the job done in most cases. At best, it will be an aid in covering funeral expenses.

• For most people Term Insurance is the most economical choice. You can get the most coverage for the least cost. That means you have more money to pay down debt and build your savings each month – both better choices than overpaying for insurance features the average family doesn’t need.

• Most experts say the amount of coverage should equal about seven to twelve times your annual income, minus any savings that will be passed on to your beneficiaries. Ten times $60,000 in income, minus the $100,000 in your 401(k), would mean you need about $500,000 in life coverage.

• Move the number up or down based on your individual obligations that might need to be handled after your passing. A large mortgage, a business loan, a child in an expensive college or sports program might need special consideration.

How it works:

If your beneficiary receives seven to ten times your annual income in benefits and puts that sum into a safe mutual fund investment, they can earn five to twelve percent in growth per year (the returns depend on how aggressive or conservative the investment is). What does that mean? They can replace your income with the money their money earns, without ever touching the original lump sum. In the above example, the family would receive $500,000 from the life insurance policy, and another $100,000 from the 401(k). Assuming they use $80,000 to pay final expenses and take some time off from work to grieve, and then pay any outstanding consumer debts, that leaves $520,000 to invest. At a safe eight percent rate of return, that would generate $41,000 per year to replace your income and support the family.

Life insurance is not about just paying for the funeral, nor leaving “fun money” for the kids. You want to keep taking care of your family, even when you can’t be there — you want your survivors to be able to afford their life.