I find that for many of my clients, life insurance sometimes plays an integral role within their estate plan. Exactly which role a life insurance policy will play, however, depends on a variety of factors. In order to know how life insurance fits into your estate plan, you need to understand the various types of life insurance as well as gain a better understanding of how to determine the amount that you need. Ultimately, life insurance should always be targeted. Ask yourself — what is my purpose in purchasing life insurance and how does this kind of policy fulfill those goals.
Life Insurance Options
Before you can decide how much life insurance you need, you need a clear understanding of the different types of life insurance available. While there are several additional hybrid options, the basic types include:
- Term Life Insurance — Term life insurance is usually the simplest and least expensive type of life insurance. A term life insurance policy is purchased for a specific amount of coverage and a specific “term”, or period of time, usually between 10 and 30 years. The premiums are usually fixed for the period of the policy. The policy has no cash value and, therefore, cannot be borrowed against. When the insured dies, the policy pays out to the named beneficiary. If the insured outlives the policy, or there is a lapse in premium payments, no benefits are paid. A variation of traditional term life insurance, referred to as “non-level” term, does not remain the same for the life of the policy. Either the premiums increase, or the payout decreases over the life of the policy.
- Whole Life Insurance – this type of life insurance is purchased in a specific coverage amount for the lifetime of the insured, hence the term “whole life.” Premium payments are usually fixed, meaning they will not change. Along with the insurance benefits, you also get a savings component and will earn dividends from the insurance company. The policy will have a guaranteed cash value. Premiums will be higher than an equivalent amount of term life insurance, but some payout at death will be certain.
- Universal Life Insurance – Universal life insurance is also purchased for a specific coverage amount; however, you may have the option to increase the coverage amount later if certain conditions are met. In addition, you may be able to change your premium payment amount if you have accumulated sufficient cash value in the policy. Your policy will usually earn interest at a rate set by the insurance company. Cash value that can often be borrowed against is one benefit to choosing universal life. One disadvantage of universal life is that, unlike whole life, it has a termination age. Although the termination age is usually not until age 95 or 100, if you live that long your loved ones won’t be entitled to any death benefits.
- Variable Life Insurance – variable life insurance is also another variation of whole life insurance. Variable life truly combines life insurance with investing. Once you accumulate savings, those savings can be invested in stocks, bonds, or mutual funds. You also have premium flexibility with variable life, meaning you can increase or decrease the amount you pay in premiums as long as you have sufficient cash value in the policy to do so. Variable life insurance offers the possibility of greater gains from the investment portion of your premiums, but also the possibility of greater losses.
- Final Expense Life Insurance – as the name implies, final expense life insurance is a specialized type of life insurance intended to help cover the costs associated with your death. It is only available to people of a certain age and usually terminates at a designated age. This type of life insurance is often used in conjunction with an Irrevocable Life Insurance Trust (ILIT) as part of a funeral planning component within an estate plan.
How to Calculate Your Life Insurance Needs
Numerous factors go into deciding how much life insurance you need. What are the needs of those you might leave behind? Do you have minor children? Do you have children who might need resources for the education. Do you have debts which you rely on you income to pay for, and thus need to pay off should you income end? Do you want to create liquidity to pay tax liability at death.
Sometimes, the liquidity that insurance provides provides your family or business partners the flexibility to maximize the return on the sale of assets at your death. We don’t know when we are going to die and don’t know what the markets will look like at the time. If the family has the money to continue for service the debt on a home, for example, that keeps them from being in the position of being forced to sell in a difficult market.
If your objective is simply to provide for loved ones if something happens to you though, a common formula looks like this:
- Add up your current resources which include after-tax income and liquid assets.
- Add your expenses and debts to determine your existing financial obligation.
- Subtract your liquid assets from your financial obligations to arrive at your “coverage gap”
- The coverage gap amount represents the minimum amount of life insurance you need – you may choose to purchase more of course.
Contact a Chapel Hill Estate Planning Attorney
If you have questions or concerns relating to how life insurance fits into your estate plan, please contact a Chapel Hill estate planning attorney at Clarity Legal Group® by calling us at 919-484-0012 or contact us online.