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How Much Life Insurance Do You Need?

How Much Life Insurance Do You Need?

(CNN) —  

When families sit down to explore life insurance options, they frequently ask the same two questions: How much life insurance do I need, and what type of life insurance should I shop for?

Just like other important decisions that families need to make, the answers to these questions aren’t cut and dry. Where some families need permanent life insurance coverage, others would be better off with affordable term coverage with a larger death benefit.

Likewise, the amount of coverage that one needs varies, depending on where you are in your career, how much you earn and the types of debts and financial obligations you have. So before you buy life insurance, you’ll want to consider exactly what you’ll get from a life insurance policy, and how much it’ll cost.

When a life insurance policy is in
 © iStock

Buying life insurance is about as fun as doing the laundry or getting your driver’s license renewed. However, having life insurance coverage is absolutely essential. If you die with a life insurance policy in place, your family will have cash they can use to pay for your final expenses, bills and any leftover debts. But if you die without coverage, your family will be left to cover all those expenses and more on their own.

 © iStock Understand the differences between term life insurance and whole life insurance to determine which one best matches your needs.

However, when it comes to life insurance, you’ll need to answer an age-old question before you invest in a policy: Should you buy term life insurance coverage, or should you invest in whole life insurance instead?

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There’s no right or wrong answer to the question of whether term life insurance or whole life insurance is best — it depends on your means and your needs. But we’ve put together this guide to help you understand the differences so you can decide whether term life or whole life is right for you.

Term life vs. Whole life: What’s the difference?

Picking a term life or whole life policy is only possible if you know how these two types of life insurance work. Once you understand how they function and their pros and cons, you can move forward with a plan and lock in life insurance coverage that works for you.

Term life insurance is one of the main types of life insurance, and it offers a death benefit for a preset period or term, usually 10 to 30 years. You’ll pay a fixed premium for the amount of coverage you want during that time, but your heirs won’t receive anything if you die after your term life policy period ends.

Most term life policies come in two forms — level term or decreasing term. Level term policies have the same death benefit for the duration of the term, whereas decreasing term life policies offer a lower death benefit as time goes on.

Whole life insurance is the other main type of life insurance — it aims to last your whole life, no matter how old you are when you die. While this means you could be paying premiums on your policy for many more years than term life, your monthly premium amount locks in at the beginning of your policy and never changes.

You’ll also build cash value that you can borrow against, thanks to the savings component of whole life policies, and many whole life companies pay dividends as well. It may even be possible to use the cash value from your policy to pay your whole life premiums.

Term life vs. Whole life: At a glance

Let’s take a look at the key differences between term life insurance and whole life insurance:

How much does term life cost vs. Whole life?

You’ve probably noticed the main advantage of whole life by now — your death benefit is guaranteed no matter how long you live, provided you pay your premiums for life. With that being said, the major downside of whole life insurance is the higher cost. By and large, you can expect to pay at least 10 times more for whole life insurance than you would for term life coverage in the same amount.

While the cost of life insurance overall varies dramatically depending on your age, how much coverage you want, the term of your policy, your health and other factors, we priced out coverage with several life insurance companies to create a comparison study.

Here’s what a 40-year-old woman or man in excellent health could expect to pay for a whole life or term life policy worth $250,000 or $500,000. The figures below are estimates and will vary based on your insurance provider, your age, your health and other factors:

Is term life or whole life best for you?

Since there’s an enormous gap between the cost of term life insurance and whole life policies, you should think long and hard about what you hope to accomplish with life insurance, as well as which type of policy would allow you to buy the level of coverage you need.

For the most part, term life insurance is best for:

Consumers who need to buy life insurance with a large death benefit

People who need affordable premiums

Anyone who only wants life insurance coverage in place for a specific length of time, such as during their working years

People who want to buy life insurance online, and perhaps even without a medical exam

Meanwhile, whole life insurance is best for:

Anyone who wants a guaranteed death benefit, no matter how long they live

People who want to build cash value they can borrow against

High-net-worth individuals who don’t mind paying higher premiums in exchange for permanent coverage

Should you buy term life or whole life insurance?

The term life insurance versus whole life insurance debate might rage on, but you should make sure you have some type of life insurance coverage in place sooner rather than later. After all, life insurance only becomes more expensive as you age. If you wait to buy coverage after you have a health condition, you may not get approved at all.

So, once you’ve understood the differences between term life and whole life and the advantages and disadvantages of each, research your options and pick an insurance policy that works best for you and your family.

Read CNN Underscored’s guide on all the different types of life insurance.

Get all the latest personal finance deals, news and advice at CNN Underscored Money.

force on an individual who passes away, the beneficiaries of the policy receive a death benefit in the form of a cash payout. Life insurance proceeds are typically used to cover:

Income replacement during the insured’s working years

Final expenses like a funeral, casket and burial plot (or the cost of cremation)

Mortgage loans, car loans and other debts

Future expenses like college tuition and children’s activities

The cost of childcare or household help

Utility bills, groceries and other basic living expenses

At its core, life insurance is meant to provide your dependents with financial support in the event of your untimely death. Ultimately, this means your beneficiaries can spend the proceeds wherever they need, whether that means using the money for living expenses, or covering the cost of future milestone events like college tuition or weddings.

The cost of life insurance can vary dramatically based on a wide range of factors. These include:

Your age

Overall health

Family health history

Occupation

Hobbies

Gender

State of residence

Amount of coverage

Type of life insurance purchased

Tobacco status

Generally speaking, term life insurance is the most affordable type of life insurance. This is because, unlike permanent life insurance coverage, term policies are only good for a specific amount of time, usually 10 to 30 years starting from when you buy the policy.

Term life insurance can even be downright “cheap” for the amount of coverage you can buy. For example, a 30-year old man in excellent health could use a company like Bestow to purchase 20 years of term life insurance worth $500,000 at a cost of less than $27 per month, whereas a woman in excellent health at the same age could buy this coverage for less than $21 per month.

Prices go up from there for permanent life insurance — way up. Whole life insurance coverage can cost as much as 10 to 20 times more than term life for the same amount of coverage. That means you could pay $400 or more per month for a whole life policy worth up to $500,000 (though a whole life policy will build cash value over time that you can borrow against).

As you shop for life insurance, keep in mind that you’ll have access to a policy with better rates if you lock in coverage while you’re young and healthy. Prices only go up as you get older, and that’s especially true if you end up with a chronic health condition or endure other physical problems that could make it challenging to pass a medical exam.

If you wait to buy coverage until you’re older or in poor health, you may wind up having to purchase guaranteed issue life insurance — a type of coverage that’s expensive despite offering a relatively low death benefit.

When buying life insurance, you’ll want 10-20 times your annual income in coverage.

PHOTO: iStock

According to financial advisor Jeff Rose, who writes about life insurance and investments for his website Good Financial Cents, most families should strive to have at least 10 times their income in life insurance coverage.

However, that’s a “minimum” to shoot for, he says, adding that 20 times your income is more in line with the amount of coverage people should carry. “This is especially true for younger families whose income is expected to increase as their career advances,” he says.

Here are some examples of coverage amounts that rely on his advice:

If you’re an individual who’s currently earning $40,000 per year, you should strive to buy life insurance coverage with a death benefit of at least $400,000, but ideally up to $800,000 or more. And, if you earn $70,000 per year? That means you need $700,000 to $1.4 million in life insurance coverage.

Conversely, high-earners who bring in $150,000 per year may need as much as $1.5 million to $3 million in life insurance.

While 10x to 20x your income is a general rule of thumb, you may want to buy even more coverage depending on your lifestyle and your needs. Individuals who have a lot of debt may want to shoot for a higher death benefit, as will those who have multiple children.

And if you believe you’ll earn considerably more money in the future, that’s another reason to buy more coverage than you need right now. After all, you can get lower rates for coverage if you’re young and healthy, whereas you’ll have to pay higher monthly premiums the longer you wait.

If you’re young and don’t have a family yet, you might wait to get life insurance coverage later down the line.

PHOTO: iStock

If you feel like you don’t need life insurance coverage, then you could be right. You may want to skip coverage for now if you’re young and don’t have any dependents or debts. Individuals who are wealthy can also decide to self-insure, and it’s possible you don’t need life insurance if you’re already retired and have cash set aside for your final expenses.

Then again, buying life insurance coverage to pay for a funeral or burial could provide your family with peace of mind no matter your age. Or, you could always take the initiative to lock in affordable life insurance rates now so you’ll have it once you need it later on.

At the end of the day, you can spend a little — or a lot — on life insurance that can replace your income and help your loved ones avoid financial losses in the event of your death. But don’t get so caught up in how much life insurance you need that you never invest in a policy. Any amount of life insurance is better than nothing, and the best policy is one you can afford.

Read CNN Underscored’s guide to the different types of life insurance.

Get all the latest personal finance deals, news and advice at CNN Underscored Money.

Small Tax Law Change May Have Big Impact On Life Insurance Sales And Values

A narrow but far-reaching federal tax law change tucked inside the year-end omnibus spending and coronavirus relief bill applies some new math to the interest rates used to define certain life insurance policies. The updates—enacted as part of the Consolidated Appropriations Act, 2021 (H.R. 133)—could usher in a healthier sales environment for life insurers and a higher savings opportunity for consumers, experts say.

Key Takeaways

A provision in the federal spending bill signed into law at year end changes a tax code rule applying to certain life insurance policies.

Under IRC Section 7702, the law adjusts key interest rates that were set more than 35 years ago and are used to define tax-advantaged, permanent life insurance policies.

The change is noteworthy because more people today rely on life insurance for more than solely the death benefit.

What Changed?

The law amends the Internal Revenue Code’s Section 7702, which defines how policies qualify as life insurance contracts under the tax code. It also spells out how much money can accumulate inside a life insurance policy without being currently taxed.

To qualify as life insurance for federal tax purposes, these policies must meet one of two tests—the cash value accumulation test or the guideline premium test. They are designed to cap the proportion of cash value to the total face amount of a policy and the amount of premiums that can be paid.

Previously, the limits in the code required life insurers to credit interest rates of 4% on the cash value of permanent life insurance and other long-term life insurance policies in order for the policies to maintain coverage until death. The issue? Section 7702 was written in 1984—when interest rates were much higher than the historic lows of today. 

Without adjusting the outdated rates to better match current, pandemic-influenced economic conditions, insurer groups feared issuing new permanent life insurance policies would be threatened, right along with the rates of return the companies generate on the investments that support their life insurance contracts payouts.

Those concerns were significant, given that permanent life insurance policies currently make up 59% of the individual life insurance market, according to data from the American Council of Life Insurers (ACLI).

“COVID’s impact on already historically low interest rates has pushed the design and funding of permanent life insurance policies to a breaking point,” says Paul Graham, ACLI’s senior vice president for policy development. “With these changes, the dramatically reduced interest earnings can now be made up for by premium dollars that the policyholder will put in, so that policies can reach their intended death benefit over the life of the policy.”

The new law drops the key interest rate used in creating life insurance policies to 2% for 2021, and ties future rates to periodically updated benchmarks after that. The reduction is effective Jan. 1, 2021 for new policies. If market interest rates normalize in the future, Section 7702 would revert to prior rates.

What’s the Impact?

Section 7702 was created to differentiate between genuine life insurance policies and investment vehicles posing as them, to make sure that only the true policies received favorable tax treatment.

The new provision should help permanent life policies continue to be characterized as tax-advantaged life insurance contracts and avoid being classified as other investments whose benefits would be taxable as ordinary income. 

What’s more, the revision makes it more feasible for insurers to offer and sell permanent life policies, notes Michel Leonard, CBE, vice president and senior economist at the Insurance Information Institute. And for consumers and policyholders, the change may create the opportunity for greater financial security, generally increasing the amounts that policyholders can contribute to cash-value life insurance accounts. (Permanent life policies have a savings component, building cash value that policyholders can tap.)

What’s Driving Life Insurance Need?

The law change is also noteworthy in light of the fact that consumers’ goals in purchasing life insurance are changing—with more of them relying on these policies for financial and retirement security.

More than half of American adults (54%) own some type of life insurance, according to LIMRA consumer research. But reasons for owning it have shifted in the past two years. Covering final expenses declined as a motivation in 2020, LIMRA found, while saving for retirement increased.

And while the COVID-19 pandemic contributed to a decline in life insurance sales in the first half of 2020, LIMRA predicts that most whole life and term products will return to pre-pandemic sales growth in 2021 and 2022. 

Term Life Insurance Vs. Whole Life Insurance: Which Is Best For You?

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