Cypress Wealth Services
April 2023
Life insurance is an essential component of financial planning for anyone who wants to shield their loved ones in the event of their unexpected death. But determining the right amount and type of coverage can be overwhelming, and many people put this decision on the back burner. In this article, we’ll take a closer look at life insurance and discuss how to determine which type and coverage level is right for you.
The amount of life insurance coverage you need depends on your current life situation, including your income level, expenses, debts, and the number of dependents relying on you. In general, life insurance is necessary if there will be a financial burden left by your passing, or if you would like to use it as an inheritance vehicle. For those with limited assets and debts and no dependents or heirs, life insurance is less important.
Life insurance is meant to replace the earning potential lost when you pass away, which means the higher your income level, the higher insurance coverage you’ll need. Similarly, if you have higher expenses or large outstanding debts (like a mortgage), you’ll want to purchase at least enough insurance to cover these liabilities.
Next, consider any dependents who may be relying on you. Do you have a spouse or children? Does your spouse work? How long will they need financial support in your absence? Do you plan to pay for your children’s college education? These are all questions to consider when determining how much life insurance you need.
Let’s take a look at the most common rules of thumb for calculating your coverage level, keeping in mind that each person’s situation is unique and it’s always best to work with a financial professional before purchasing an insurance product.
This rule suggests you should have life insurance coverage equal to 10 times your annual income. For example, if your annual income is $75,000, you should have $750,000 in life insurance coverage. This rule of thumb jumps to 20 times your annual income if you have young children or a dependent spouse.
This rule suggests you should consider four factors when determining the appropriate amount of life insurance coverage: debt, income, mortgage, and education. Add up your debts (like credit cards, auto loans, and personal loans), multiply your annual income by the number of years you want to replace it, add the amount of your outstanding mortgage, and add the cost of your children’s education. This will give you a rough estimate of how much coverage you need.
This method involves a more comprehensive evaluation of your financial needs. It takes into account factors such as your current and future income, your debts, your children’s education, and your retirement savings. A financial advisor can help you with this analysis and determine the appropriate amount of coverage for your situation.
After you have a general sense of the coverage level you need, it’s important to understand the types of life insurance available.
Term life insurance is typically less expensive than other types of insurance. It provides coverage for a specified period of time, usually 10, 20, or 30 years. But the use-it-or-lose-it nature of a term policy is a big drawback. If you pass away during the specified term, your beneficiaries will receive a death benefit; but if you don’t die during the term, the policy expires and you get nothing. All the money you spent on premiums will be gone too.
Because term life insurance is one of the least expensive and simplest types available, it’s typically recommended for those who only want coverage for a specified period of time, like until your kids reach a certain age or your mortgage is paid off.
Permanent life insurance is more expensive than term life insurance because it covers you for your entire life. As long as you pay the premiums, your beneficiaries will receive a death benefit when you die.
Permanent life insurance also has an investment component known as cash value. This cash value grows over time and can be used to help pay premiums or it can be borrowed against in case of an emergency. There are two main types of permanent life insurance: whole and universal.
- Whole Life Insurance has a guaranteed death benefit and coverage that applies as long as your premiums are paid. Coverage will not decrease or be revoked, and premiums will not increase or decrease over the life of the policy. Coverage can increase based on increases in cash value or reinvestment of dividends, but it will never decrease below the guaranteed value. The growth of the cash value can be based on a fixed rate of interest or it can be variable. The cash value will grow on a tax-deferred basis, but once money is withdrawn from the policy, any earnings will be taxable as ordinary income.
- Universal Life Insurance has a flexible premium and death benefit. The premium is usually lower than whole life, but the policy usually comes with fewer guarantees. With this type of insurance, policyholders can choose how their premium payments are invested, which can provide significant growth potential for the cash value of the policy. It is also riskier than whole life because major investment declines could cause your premium payment to go up next month in order to keep the policy in force. Generally, universal life policies are recommended for those who have a higher risk tolerance and want a greater degree of control over their insurance investments.
If you’re unsure about your life insurance coverage, consider working with a financial advisor or insurance agent to determine the right policy for your needs. Having the proper life insurance coverage in place is crucial for safeguarding your loved ones in the event of your passing. Remember, life insurance is not a one-time decision; it’s important to review your coverage regularly to feel confident it continues to meet your needs.
At Cypress Wealth Services, we help high-net-worth individuals, families, and business owners find confidence in their long-term financial futures. If you have questions about your life insurance or would like to discuss your overall financial situation, call us at 866.888.6563 or contact one of our offices to get started today.
Cypress Wealth Services is an independent RIA firm providing financial planning and investment management to high-net-worth individuals, families, business owners, and institutions. Cypress Wealth Services comprises professionals with diverse backgrounds and extensive experience and qualifications. Cypress Wealth Services serves a broad range of client needs using their experience and expertise to act as a foundation for their client service process. The firm uses The Second Growth, which focuses on efficiently protecting, growing, and transferring the wealth and legacy a person has already built to their loved ones. With financial advisors in Palm Desert, CA, Tustin, CA, Athens, GA, and Anchorage, AK, the firm serves clients across the country with Wealth Management Services, Fiduciary Services, 401(k) Design and Management, Investment Reporting Services, Financial and Retirement Planning, and more. For more information, visit www.CypressWS.com or call 760.834.7250.
