by Christian Hudspeth, CFP®
“Should I keep my life insurance policy?”
This is a question our clients often ask, especially those who have been paying life insurance premiums on their policies for several years or decades.
To explore this question, let’s review life insurance’s main purpose.
Why and When It’s Important to Have Life Insurance
While there are several reasons why people buy life insurance, many see the product as a solution to the burning question: “will my family have enough money to financially support themselves if I were to die today?”
Here’s an example of someone that may need life insurance. Charlie is a husband and father in his working years who is still saving for retirement. Because his family depends on his income, they would face financial hardship if he were to die suddenly. However, if he were to die with enough life insurance, Charlie’s family would receive tax-free proceeds that could be invested on their behalf and distributed out to them each month to cover their needs for several years, or even for the rest of their lives if needed. Life insurance may be a good option for Charlie.
Now we look at when it may be a good idea to end a policy. After a decade or two of paying premiums on his life insurance policy, Charlie’s dependents have grown up and can financially support themselves. And because he’s been diligently saving, Charlie has accumulated enough assets (e.g. stocks, bonds, and real estate) to financially support his spouse if he were to die. At this point, Charlie may no longer need life insurance and can choose to stop making premium payments and effectively cancel his policy.
Of course, like all decisions in financial planning, this story doesn’t fit everyone’s situation, and there are times when it may make sense to keep the life insurance. So before you decide to buy, keep, or drop a life insurance policy, here are four questions to ask yourself first:
1. Have you saved enough in sellable assets for your financial dependents to live on?
Do your loved ones still rely on your working income to live? If you’re not working, did you save enough investment assets for them to be able to sell and live on for the rest of their life should you die today?
A general rule of thumb is you should have 10 times your annual income saved and/or covered by life insurance. And while that’s a start, keep in mind this one-size-fits-all calculation does not always meet the needs of every family given their lifestyle needs, the ability for a surviving spouse to get a job, potential inheritance, and various other factors that come into play. More on that below.
2. Do you have a pension or annuity that keeps paying your spouse after your death?
Some retirees choose to take a “straight annuity” when making their pension decision. While this pension option lets them receive the largest monthly payout compared to the various joint and survivor options offered, the downside of the straight annuity is it stops when the pension holder/annuitant dies and the surviving spouse may no longer receive the income.
If you chose the straight annuity option, or a reduced joint and survivor option, and you were to pass away today, you could unintentionally force those who financially depend on you to sell the family home, make significant lifestyle cuts, or even live in poverty. Hence, a potential need for life insurance.
3. Do you have significant, shared debt (or financial goals) with your spouse?
Are you and your spouse co-signers on a mortgage or auto loan? Did you take out loans or credit lines after you were married in a community property state?
Without enough savings and sellable assets, you may need at least enough life insurance to pay off the debt if you were to die today to ensure your loved ones aren’t forced to sell your home or car to satisfy creditors.
Financial goals may fit into this category, too. For example, if saving toward your child or grandchild’s college education is very important to you, life insurance could be key to ensuring that goal is met if you passed away early.
4. What about other costs that could arise upon your death?
If you were to die and leave your spouse to care for a child with a disability, grandchildren you are guardian over, or elderly parents that depend on you, you may need enough life insurance to pay for daycare, a nanny, or long-term care if you don’t have enough in liquid savings. You may also need to include coverage to pay a tax accountant or financial advisor to help your spouse manage the family investments or taxes when you are gone.
For those with a net worth above $10 million, life insurance can be a way to 1) provide liquidity to pay for final expenses, 2) pay potential estate taxes, and/or 3) leave a legacy to your heirs or your favorite charities. Read more in Life Insurance and Estate Planning.
How much life insurance do you need, if any?
However you answered the questions above, it’s important that you only pay for the amount of life insurance coverage that accurately matches your family’s needs.
If you buy too much life insurance coverage or don’t need coverage in the first place, you could be costing yourself a lot of money in unnecessary premiums that you could be using to enjoy life. But, if you underestimate your coverage needs, you may leave your loved ones in a financial bind while they are in the middle of grieving your loss.
A customized financial plan is by far the most accurate way to calculate how much life insurance you need for your unique situation. When crafting a financial plan for you, a trustworthy financial advisor with a skilled planning team will consider factors such as:
- Your family’s current income and lifestyle needs
- Your sellable assets
- Your debts, including your mortgage, and who is responsible for paying them
- Your future financial goals, such as education or travel
- How much life insurance you might need to invest to keep your surviving spouse on track with their retirement goals
- And, most importantly, how to make your investments last through inflation, poor market conditions, and major life events.
Don’t take shortcuts or leave this decision to chance. Instead, work with a financial advisor that can help you figure out your life insurance need, or if you need life insurance at all. That way you’ll have peace of mind that your loved ones are financially taken care of, whether you are gone today or at age 100.
More from FMP Wealth Advisers:
Pensions: Get Income for Life or Take the Lump Sum?
Our Top 5 Most-Asked Social Security Questions
Life Insurance for Those with a Net Worth over $10 Million
*The information presented here is not specific to any individual’s personal circumstances. FMP Wealth Advisers is not providing investment, tax, legal, or retirement advice or recommendations in this article.
**To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances.
***These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable — we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.
