Don't Let the Kind of Life Insurance You Buy Kill You
A Suze Orman exclusive
When you become a parent you are making an irrevocable pledge to take care of that child in every way possible. So you need to make sure that no matter what happens to you, your child will be financially okay. By that I mean that your spouse or partner, or a guardian, would have the resources to raise your child if something happened to you.
Yup, we're talking about life insurance. Don't give me that glazed-over look. It isn't nearly as difficult to figure out as you might think, and it is the single biggest gift you can ever give your loved ones - especially if you are a single parent.
There are a variety of types of insurance on the market, but you can make the shopping easier by focusing on what is known as Level Term Insurance. As the name implies, you will be covered for a certain "term" of time, anywhere from 1 to 30 years. "Level" means your monthly premiums will stay the same during the entire policy period. If you die during the term, your death benefit - which will be income tax-free, as with most types of life insurance - would pass to your named beneficiaries on the policy. If you live out the length of the term, you get nothing at all.
So now let's say you do live longer than the term of the policy you buy-what then? Well, first of all, congratulations; the primary reason to buy life insurance, in my opinion, is to make sure that while you are young and haven't had a chance to build up your assets, you still have a way to protect those who are financially dependent upon you in case you die unexpectedly. As you get older and hopefully acquire more assets, and as your children become independent, the need for insurance steadily lessens and may even disappear completely. But if that's the case, then why, you will almost certainly find yourself asking, is my insurance agent making me buy another policy to cover the rest of my life? That is the $64,000 question. And the answer involves whose pockets the money ends up in: yours or the insurance agent's. The kind of life insurance policies that many agents will tell you about are known as variable life, whole life, or universal life. You will hear that these policies are the best way for you to save for your future-tax free-as well as insure you to the end of your life. But here's what I will tell you that they probably won't: Many (not all, but many) insurance agents love to push these policies chiefly because they reap big commissions, especially in the first year of the policy when the majority of the premium goes to them. It is an argument I have been having with agents for years, and will happily continue
to do so. In my opinion, level term insurance is usually the best way to go for the vast majority of people.
How Much and for How Long?
Before I explain why term is the only kind of life insurance I want you to buy, first I want you to know how to decide how large a death benefit you want for your policy, and how long you want that death benefit to last. My rule of thumb with term life insurance is to always anticipate the worst case scenario and then buy enough insurance to cover you and your family if the worst comes true. I know you think it can never happen to you. So did the brand-new parents in Connecticut I remember reading about earlier this year, whose car was crushed by a tree. They were both killed in the accident; their baby was found unhurt. We are not comfortable thinking in terms of sudden and total catastrophes like this, but unfortunately they do fall within the realm of the possible. Don't assume, for instance, that your spouse will survive you and be able to support your child after a period of transition. Buying only enough insurance so your loved ones can get by for a few months or a year is simply failing to fulfill a critical obligation to your family.
The Magic Formula
Let's say you want to make sure that should you die your beneficiary would have an income of $100,000 a year for the rest of their life. That means you want a death benefit large enough to generate $100,000 in annual income. To figure that out just multiply the yearly amount of income you want your loved one to have by 20. In this case, $100,000 a year multiplied by 20 equals $2,000,000. Why 20? It all has to do with the rate of return your beneficiaries could earn on the death benefit payout. And I want you to play it conservative, so we are going to do our calculation based on a 5 percent rate of return, which is what you probably can get on a high-quality individual bond investment. So a $2,000,000 death benefit invested at 5 percent will give your beneficiaries the $100,000 a year of desired income.
Next, you need to decide how long you want your policy to last. That's what is known as the term. You should choose a term that lasts until your youngest child is about 24 years of age. By that time, a (grown) child should be able to take care of himself or herself if something were to happen to you. (A side note: If you do not have kids but there is someone in your family who is financially dependent upon you, choose a term that gives you enough time to build up your assets to the point where you will no longer need the insurance.)
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