One of the best parts about life insurance is that it’s a contract with an insurance company in which you select a beneficiary of the policy. The reason this is important is for the fact that life insurance proceeds pass outside of probate, meaning that your beneficiary doesn’t have to wait months (and sometimes years) before they receive the death benefit.
While this won’t be of importance to you, the way life insurance works is that your beneficiary will be responsible for contacting your life insurance provider at the time you pass. So, make sure your beneficiaries know where your policy is located. Once contacting the insurance provider, they will require your beneficiary to fax or mail the Death Certificate. As long as there isn’t anything too suspicious, the life insurance company will then send out a check for the full death benefit to your designated beneficiary.
Sometimes there are options to spread out the death benefit over a specific period of time, but in most cases people opt for the lump-sum payout. Lastly, the most important part about a life insurance payout is that it’s passed TAX FREE to your beneficiary. So, if you have a $300,000 policy, your beneficiary will receive the full $300,000 without having to pay taxes on it!
1. Income Replacement
The most common purpose for life insurance is to cover the loss of one’s income. If you’re married or have children, and your family is dependent on all or a portion of your income, then having life insurance is imperative. In these situations where you’re looking to replace income, it’s best to have somewhere between 10-15x’s your annual income.
Another big part that life insurance can cover is the debt that you have. In many cases, your debt does not die with you and it will still be around for your spouse or for your estate to cover. Particularly a mortgage, credit card debt, and car loans come to mind.
If you want life insurance to cover your income as well as the debt, then use that 10-15x’s your annual income rule and then add the amount of debt you have. For instance, if you make $50,000/year and have $300,000 worth of debt (including the mortgage), then having a death benefit of $800,000 to $1,000,000 should suffice.
3. College Tuition
I’ve run into a few situations where a family wanted to include the cost to cover their children’s tuition. While this might not be a desire for everybody, and some may think that they’re over-insuring by adding all of these additional costs to their death benefit, life insurance can cover just about anything you want. So, if you have young children and you want to ensure they’ll have their college covered in the event that you die prematurely, then I’d encourage you to add another $100,000 (or more) per child to the death benefit.
As a financial advisor, the 2nd most common scenario that I see life insurance used is to leave an inheritance to children or charity. The fact that life insurance passes TAX FREE to beneficiaries makes it an extremely valuable planning tool if the desire of the family is to leave money behind.
Recently, I had a family specifically tell me that they wanted to leave $150,000 to their daughter. While they didn’t have the assets to set aside so they could specifically accomplish that goal, life insurance then became an easy solution to accomplish their wishes. After discovering they only had to pay $120/month to cover that their goal, the decision quickly became a no-brainer. By doing a little math (not including interest earned otherwise), you can calculate that they’d need to save that $120/month payment for 104 years before they could have accumulated $150,000 on their own!
Life insurance can be a very powerful tool for legacy planning and to protect your family in the event of a premature death. In most cases, especially if you’re healthy, the cost of insurance is simply too cheap to pass up.
I know many of my readers have life insurance…so, what purposes do you have planned for it? Is it to cover the loss of your income or have you thought about using it in terms of inheritance planning?
The articles are written by personal finance enthusiasts (not certified professionals) based on their personal experience. What works for them may or may not work for you, and you should always consult a financial advisor before making important financial decisions.
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