Life insurance isn't the most exciting topic (even moderately so), but it's a tool to protect your assets, income, and most importantly - your loved ones, in the event of an unexpected death. Here's everything you need to know about life insurance, including the different types, calculating your needs, and where to get it.

WHY LIFE INSURANCE?

When I was a financial planner, a client of mine lost her husband to heart disease. He didn't have life insurance, saying things like "who cares? I'll be dead anyway", assuming his assets would simply go to his wife.

Unfortunately, things didn't work out that well. When he died, he left massive debts, his assets were seized and held for months (since there was no will), and after two years of financial agony and logistical nightmares in the wake of her husband's death, my client would have divorced her late husband if she could have. (See Also: Estate Planning: What it is and Why You Should be Doing It).

Life insurance eases the burden of the people who survive you. It's not a windfall; even policies for hundreds of thousands of dollars are usually calculated precisely. (We'll explore how shortly).

Some reasons to get life insurance:

  • Pay for children's higher education
  • Provide income for dependent spouse/family members
  • Pay off debts and mortgage
  • Cover estate expenses and taxes
  • Create a legacy
  • Utilize tax-preferred investment shelters 

TERM vs PERMANENT LIFE INSURANCE

The two main types of life insurance are term and permanent. Here are the differences:

Term Life Insurance

Term life insurance is intended for temporary (or changing) needs. Most common is Term10, which guarantees your premiums for 10 years; at renewal the price goes up (significantly), but continues to be guaranteed - at 10 year increasing rates - until around age 65.

You don't normally keep a term policy straight through however. At 10 years, you reevaluate your (temporary) insurance needs, and as long as your health hasn't deteriorated, you can reapply for a new policy at much lower rates.

Some uses for term life insurance:

  • Children's education
  • Debts
  • Mortgage
  • Income needs for surviving family members

Permanent Life Insurance

Permanent life insurance, as the name indicates, is for permanent insurance needs, such as the following:

  • Anticipated estate taxes
  • Leaving a legacy
  • Equalizing inheritances between beneficiaries

Permanent life insurance comes in "Whole Life" and "Universal Life" insurance policies. They are very different forms of insurance but share the following qualities:

  • Rates are guaranteed for life
  • Policies never expire
  • There is an additional tax-sheltered investment component
  • Generally more expensive than term insurance

The complexities of permanent insurance go beyond the scope of this article; if permanent insurance intrigues you, consult your financial planner for more information.

CALCULATING LIFE INSURANCE NEEDS

To calculate your life insurance needs, start with your last semi-annual financial review, which includes a statement of your assets, liabilities, and income. (For more: How to Perform a Semi-Annual Financial Review).

Then, use the formula below as a guide:

Immediate Expenses

Add up the following:

  • Final Expenses (funeral, medical, legal, taxes, etc - $5-15,000 recommended)
  • Total Debt (other than mortgage)
  • Housing Fund (to pay off mortgage/buy a house/pay rent for "x" years)
  • Survivor Fund (income for survivor to adjust; approx 12 months)
  • Emergency Fund (household expenses for 6 months)
  • Education Fund (approx $30,000 per child)
  • Extra Funds (charitable gifts, wedding fund, child care, extra expenses)

Income Requirements

Calculate the following for ongoing income requirements:

  • How much do survivor(s) need to live? (approx 70% of current household income)
  • Subtract continuing income (government benefits, survivor's income, etc)
  • Multiply by number of years additional income is required

Immediate Assets

Add up the following, only including assets that would be be sold to cover the above needs):

  • Cash
  • Personal Life Insurance
  • Group Life, Mortgage, and other Loan Insurance
  • Government Death Benefit (if applicable)
  • Residence/Real Estate
  • Non-retirement Investments
  • Business Equity
  • Other Assets (cars, art, jewelry, etc)

Lastly, add the total Immediate Expenses and Additional Income Required amounts, then subtract the Immediate Assets from that number. The number you arrive at is your current additional life insurance need.

WHERE TO GET LIFE INSURANCE

Don't reinvent the wheel by shopping the market for life insurance yourself. That's the job of an insurance broker - or better yet, a comprehensive financial planner, who can source the best policy for your needs using their industry knowledge and connections. (See also: 15 Things to Expect From Your Financial Planner).

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Nora Dunn, travel and lifestyle expert guest blogger for leading provider of debt relief, CareOne Services, Inc. Nora Dunn

Nora Dunn is The Professional Hobo: a full-time traveler and freelance writer. Having sold her business and belongings to travel, she has been on the road since 2007. She travels in a financially sustainable manner, specializing in creative travel strategies like getting free accommodation and flying in business class for less than economy prices; all the while earning income with her location independent career.

As a former Certified Financial Planner, she is financially responsible for her actions along the way. She believes there is a fine balance between planning for tomorrow, and living for today.

She has penned the book How to Get Free Accommodation Around the World, is contributing author to the book 10,001 Ways to Live Large on a Small Budget, and a regular columnist for Wise BreadTransitions Abroad, Credit Walk and many other publications.

Please enjoy her articles on the topics of travel, personal finance, and lifestyle design.

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