Do I need life insurance?

What is life insurance?

Life insurance is a financial product that pays out a death benefit when the covered person passes away. The policyholder pays a monthly or annual premium based on the death benefit and type of insurance policy. When the covered person dies, their beneficiaries receive the policy's death benefit. This money can be given to one person (such as a spouse), shared with multiple people (like your children) or to an organization (e.g., a charity).

Life insurance comes in many forms, including cash value, term and whole life. Each policy type has different pros and cons depending on your specific financial needs and goals. To find the best life insurance policy, many people work with a life insurance agent to compare quotes, analyze policy types and determine how much death benefit they need.

» MORE: What is cash value life insurance?

Who needs life insurance?

Life insurance is a smart choice when you need to protect against a financial risk. Whether you need to replace lost income, pay off debt or have other needs, life insurance provides the money to cover those bills when someone dies.

Here are a few situations where life insurance can help after the loss of a loved one:

• You’re a wage earner: Many families live paycheck-to-paycheck, and the loss of a wage earner can cause significant financial hardships. Even families who are well off financially can struggle if they lose one of their paychecks. Life insurance can replace that lost income and help cover normal monthly expenses.
• You’re a caretaker: While many caretakers and stay-at-home parents don’t earn an income, paying someone to take over their family duties can cost a lot of money. A life insurance policy can provide the money a surviving parent needs to take care of their family without having to give up their career.
• You’re a homeowner: A mortgage is one of the largest debts you’ll ever take on. Life insurance proceeds can pay off this debt to give your family a debt-free home that doesn’t require costly monthly mortgage payments.
• You’re a parent: Sending a child to college is a goal for many parents. Considering tuition costs are rising 9.24% over a 10-year span, paying for college can be expensive. Life insurance can cover tuition and room and board, ensuring that your children attend school without worrying about how much it costs.
• You’re estate planning: Some families purchase life insurance to cover estate taxes that may become due when the owners pass away. These families find it worthwhile to pay the premiums to avoid an estate tax bill when their net worth is above the estate tax exclusion amount.
• You own a business: Being in business often requires taking on debt, signing leases and hiring employees. If you have a business partner, you also must contend with ownership issues when an owner passes away. A life insurance policy that covers business debt and buying out your share of the company is a smart decision. In some cases, it can even be a requirement for the bank to approve your loan.

Who doesn’t need life insurance?

Life insurance addresses financial risks due to loss of income, debt obligations and future expenditures. If you don’t have debt, children or other financial worries, you may not need to purchase life insurance at this time.

Jiten Puri, the CEO of PolicyAdvisor, a life insurance comparison site, told us: "Someone with a significant amount of savings and no debt or dependents may not necessarily need life insurance." Still, Puri said, "Just about anyone who has financial obligations, or who wants to provide for their family after their death, should consider buying life insurance."

Even if you don’t need life insurance now, many people purchase life insurance ahead of future needs. Single people often purchase life insurance when they are young and healthy to lock in lower premiums ahead of buying a home, having children or starting a business in the future.

Types of life insurance

Gordon Conwell, a life insurance specialist at American Term, told us that the decision "may come down to budget and/or how long you would like to maintain the life insurance.”

Conwell explained, “Term insurance can be inexpensive but is always a shorter-duration solution compared to permanent life insurance. Permanent insurance is always more expensive than term, but it will last for your entire life with premium payments that never change."

Term life insurance

Life insurance coverage for a specific term is called term life insurance. These policies offer fixed premiums for a set number of years, and then the premiums increase each year. Like auto or medical insurance, term life insurance coverage is in place as long as you make the premium payments.

People can choose terms of up to 30 years that match their needs. Fixed premium options typically include one, five, 10, 15, 20 and 30 years. When these terms expire, premiums usually increase each year thereafter.

Whole life insurance

Whole life insurance is a cash value life insurance policy that covers people for (basically) their whole life. The premiums and death benefit stay the same throughout the term of the policy. However, whole life policies tend to cash out when the insured reaches 100 years old.

Universal life insurance

A universal life insurance (UL) policy is permanent insurance that accumulates cash value. Your monthly premiums are a combination of insurance and cash value that is invested in stable value investments. These investments offer a consistent interest rate similar to money market accounts, certificates of deposit (CDs) or Treasurys.

Policy owners can contribute additional cash, up to a maximum limit, to accumulate a higher balance. Like an annuity, increases in cash value don't trigger taxable income. It is possible for your death benefit to increase beyond the original amount if your cash balance becomes large enough.

Some investors borrow against the cash value to access the money during their lifetime without triggering taxes. If a loan is outstanding at the time of death, the balance is subtracted from the life insurance proceeds.

Variable universal life insurance

Variable universal life insurance (VUL) operates in a similar fashion to a UL policy. However, the major difference is that the cash value is invested in stock and bond investments. These diversified pools of investment offer stakes with different types and sizes of companies with varying terms and degrees of risk. As with any type of investment, it is possible for your invested cash to go down in value.

How to get life insurance

If you’re ready to get life insurance, follow these seven simple steps to get your policy.

1. Determine how much coverage you need. Coverage amounts can vary widely based on how much income you need to replace, debt you want to pay off, college tuition plans and other factors. A good rule of thumb is ten times your annual income plus the price of those other factors. If you expect your income to grow significantly during the policy term, you may want to factor that in as well.
2. Identify the right type of insurance policy. There are numerous types of insurance policies to address different needs and goals. Choosing the best type of insurance policy for your situation narrows down the choices of which insurance companies to get quotes from.
3. Compare quotes from different life insurance companies. Get quotes from several insurance companies to compare annual premiums, benefits and financial strength. People often get quotes online, talk with an insurance agent or use an online comparison tool that provides quotes for multiple companies at once.
4. Choose which company to apply with. Select a company that matches your budget and needs. The company’s financial strength provides assurances that it will be able to pay out claims in the future.
5. Submit your application. Complete your application online, over the phone or in person with a life insurance agent. In some cases, preliminary coverage may begin immediately after making an initial premium payment, pending a medical exam.
6. Perform the medical exam (if necessary). Insurance companies often require a medical exam, blood test or a physical before they’ll issue the insurance policy. For policies above a certain dollar amount, further testing may be required before they approve your life insurance.
7. Pay for your policy. The final step for your life insurance to be in effect is to pay the premium. Companies may offer a discount for paying annually instead of monthly. Term policies end when you stop paying, while cash value life insurance policies may continue until the cash value runs out.

Bottom line

Life insurance offers financial resources to family members when a loved one passes away. There are multiple types of life insurance to meet the needs and budget of every family.

Typically, you’ll choose a death benefit large enough to replace the lost income of the deceased, cover burial expenses and pay off personal and business debt. You can get quotes for life insurance online, over the phone or in person with a life insurance agent. Compare quotes, benefits and financial strength of multiple companies before purchasing your policy.