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Updated on Thursday, November 10, 2016
The majority of healthy Americans can use term life insurance policies to get sufficient coverage in place for anywhere from $15 to $100 a month. Most (85%) American consumers believe that most people need life insurance, but just over 60% carry a policy. Even among those who carry a life insurance policy, the amount covered is frequently not enough.
Term life insurance is a low-cost way for individuals with financial dependents to meet those people’s needs even after death. But it can be confusing to understand what it is and what it covers.
When to Consider Life Insurance
Anyone who has a financial dependent should consider buying life insurance if they don’t have the assets available to cover their dependent’s financial needs in the event of their death.
There are five major events that create financial dependence and may justify the purchase of life insurance. These events include:
- Taking on unsecured debt with a co-signer
- Taking on secured debt with a co-signer
- Having a child
- Moving to a single income
How Much Life Insurance Do I Need?
Term life insurance is the cheapest form of life insurance, but carrying too much life insurance is a waste of money. The exact amount you decide to carry will depend on your risk tolerance and the size of your financial obligations. In this article we offer rules of thumb that can help you calculate the financial loss associated with your death.
Most life insurance companies and brokers also offer life insurance calculators, but these calculators rely on averages. Since each person’s situation is different, it can be valuable to create an estimate on your own.
Unsecured debt with a co-signer
If you’ve taken on unsecured debt (like student loans) with a co-signer and you don’t have sufficient cash or investments to cover the debt, then consider purchasing life insurance in the amount that is co-signed. The beneficiary of this policy should be the person who co-signed the loan with you.
For example, if your parents have taken out $50,000 in loans via a Parent PLUS Loan or private loans, then you should take out a $50,000 policy with your parents as the beneficiaries. In most cases involving unsecured debt with a co-signer, a short term (such as 10-15 years) will be the most cost-effective option for covering this debt.
Secured debt with a co-signer
Secured debts (like a mortgage or a car loan) have some form of capital that could be sold to pay off most or all of the loans, but you still might want to consider taking out life insurance for these types of debts.
While your co-signer can sell the asset, pay off the debt, and become financially whole, that may not be the right choice for your situation (especially if the co-signer is your spouse).
For example, a couple that takes out $200,000 for a 30-year mortgage may decide to each take out a $200,000, 30-year term life insurance policy. This policy will allow either spouse to continue to live in the house in the event of the other’s death.
Marriage isn’t a financial transaction, but it brings about financial interdependence. In the event of your death, the last thing you want your spouse to be concerned about is their finances.
Couples without children who both work aren’t financially dependent on each other, but many people would still like to provide their spouse 1-3 years’ worth of income in life insurance to cover time off from work, final expenses, and expenses associated with transitioning houses or apartments.
A couple who each earn $40,000 per year, and who have $20,000 outside of their retirement accounts, can consider purchasing life insurance policies between $20,000-$100,000 in life insurance to provide for the other’s financial needs in the event of their death.
Having a child
Because children are financially dependent on their parents, parents should carry life insurance to cover the costs of raising their children in the event of a parent’s death.
The estimated cost of raising a child from birth to 18 is $245,000, so it is reasonable for each parent to carry a policy of $100,000-$250,000 per child. It is especially important to note that stay-at-home parents should not neglect life insurance since their death may represent a big financial loss to their family (manifested in increased child care costs).
The beneficiary of this life insurance policy should be the person who would care for your child in the event of your death. Sometimes this will be your spouse, but sometimes it will be your child’s other parent, or a trust set up in your child’s name.
If a couple has two children under age 5, and $50,000 in accounts outside of retirement, then each parent should have between $150,000 and $450,000 in life insurance. Parents of older children may choose to take out smaller policies or forego the policy altogether.
If your spouse is dependent upon your income to meet their financial needs, then it is important to purchase enough life insurance to care for their immediate and ongoing financial needs in the event of your death. If you are the exclusive income earner in your house or if you co-own a business with your spouse that requires each of you to play a role that the other cannot play, then your death would yield a tremendous financial loss for several years or more.
In order to estimate the size of policy needed in this situation, there are a few guidelines to consider. According to the well-respected Trinity Study, if you invest 25 times your family’s annual expenditures in a well-diversified portfolio, then your portfolio has a high likelihood of providing for their needs (accounting for inflation) for at least 30 years. A policy worth 25 times your annual income, less the assets you have invested outside of retirement accounts, is the maximum policy size you should consider.
Many people choose to take out even less than this because their spouse will eventually choose to return to work. A second rule of thumb is that the total amount of life insurance for which your spouse is the beneficiary should be worth 10-12 times your annual income. A policy of this size would reasonably provide money to pay for living and education expenses (if your spouse needs to re-train to enter the workforce) for many years without damaging your spouse’s prospects of retirement.
Based on these rules of thumb, if you earn $100,000 and your family’s expenses are $70,000 per year, and your spouse is a stay-at-home parent, then you should have enough life insurance to pay out between $1 million and $1.75 million (remember to subtract the values of any other policies or non-retirement assets above when calculating this amount).
How to Shop for Life Insurance
After deciding on the amount of insurance you need, and the terms you need, you can start shopping for the best policy for you. Although it’s possible to shop around for the best insurance, MagnifyMoney recommends that most people connect with a life insurance broker. For this report, every quote received from a broker was within a few cents of the quote received directly from the insurance company.
If you tell a broker exactly what you want, they can pull up quotes from a dozen or more reputable companies to get you the most cost-effective insurance given your health history. This is especially important if you have some health restrictions.
People with standard health (usually driven by high blood pressure or obesity, or many family health problems) may find some difficulty finding low rates, but brokers can help connect them with the right companies.
People with “substandard health” because of obesity, high blood pressure, or elevated cholesterol, those suffering from current health issues, or people recently in remission from major illnesses will not qualify for term life insurance.
Top Three Life Insurance Brokers
- PolicyGenius – PolicyGenius is an online-only broker with an easy-to-use process and helpful policy information. Users give no contact information until they are ready to purchase a policy. PolicyGenius’s system saves data, so users don’t have to re-enter time and again. It is very easy to compare prices and policies before applying.
- Quotacy – Quotacy is an online-only life insurance broker with connections to more term life insurance companies than most other life insurance companies. Quotacy offers quick and easy forms to fill out, and they do not require that you give contact information until you are ready to purchase a policy. Unfortunately, they do not fully vet out the policies, so you may need to ask an agent questions before completing a purchase.
- AccuQuote – AccuQuote is an online-based brokerage company that specializes in life insurance products. Unlike the online-only brokerage systems, their quotes are completed through a brokerage agent via a phone call. People who prefer some human interaction will find that AccuQuote emphasizes customer service and offers the same price points as online-only competitors.
Top Life Insurance Companies
For those who prefer to shop for life insurance without the aid of a broker, these are the top five companies to consider before purchasing a policy. Each of these companies allow you to begin an application online though you may need to connect with an agent for more details (including a rate quote).
To be a top life insurance issuer, companies had to offer the lowest rates on 30-year term insurance for preferred plus or preferred health levels, and be A+ rated through the Better Business Bureau.
- Allianz – Allianz offers the lowest rates for both Preferred and Preferred Plus customers, but they do require you to contact an agent or a broker for a quote.
- Thrivent Financial – Thrivent Financial offers the lowest rates for Preferred Plus customers, but they require you to contact an agent before they will confirm your rate.
- American National – American National offers among the lowest rates with Preferred and Preferred Plus customers, and they work closely with all major online brokers. You must contact an agent to get a quote directly from them.
- Banner Life Insurance (a subsidiary of Legal & General America) – Banner Life Insurance offers an online quote portal and very low rates for Preferred Plus customers. They also seem to be a bit more lenient on the line than other customers for considering Preferred Plus (not considering family history).
- Prudential – Prudential offers an online quote portal and the lowest rates for Preferred customers.
What to Expect Next
After you’ve decided to purchase an insurance policy, the policy will need to undergo an underwriting process. This will include a quick medical examination (height, weight, blood pressure, urine sample, and drawing blood) that usually takes place in your home. After that, the insurance companies will need to collect and review your medical records before issuing a policy for you.
Underwriting typically takes 3-8 weeks depending on how complete your medical records are. The company will then issue you a policy, and as long as you continue to pay, your policy will remain in effect (until the expiration of the term). Once your policy is in effect, you can rest easy knowing that your financial dependents will be taken care of in the event of your death.