The answer from most financial advisers is an emphatic “always” when someone asks them if they should buy life insurance. While they may be a bit overenthusiastic in their sales recommendations, the truth is that there are many events in a person’s life that will create a need for life insurance.
The academic definition of when life insurance should be purchased is whenever there is a financial risk to another person (or group of people like a family) if another person passes away. This means that if someone passes away and it affects another person’s financial situation negatively in any way because of the death, there is a legal right to own life insurance on that person. If someone has a right to own life insurance on another person’s life, they are said to have an insurable interest. A person is always assumed to have an insurable interest on their own life, and the lives of their immediate family members.
Keeping that in mind, a legal right and a necessity are two very different things. There are times when life insurance is a clear necessity and others when it is less of a necessity, but owning it may still serve a purpose,such as for investment or complex business matters. Highlighted here will be the life events when the need for life insurance is most pressing.
The first reason most people encounter in their lives which necessitates the purchase of life insurance is marriage. When two people marry, they quickly begin to depend upon each other financially. Joint purchases are made, joint debt is owned, and expenses are shared. Whether one partner provides the majority of the income, or both contribute equally, it is a good idea for both partners to own at least some life insurance on each others lives. Especially if children are involved, the value of the person(s) providing childcare and the person(s) earning income are both difficult to replace.
The most basic cost of a death during a marriage is the funeral expense itself, and other expenses related to the death. Funeral costs can top $30,000, and added to this cost most surviving partners must also miss a significant amount of time from work. The costs of a funeral and other associated grieving costs can be a very expensive hindrance to the well being of the remaining spouse.
Protection from lost future income (especially considering raises and promotions over the course of a career) is often the most important kind of protection that life insurance can offer a spouse. When you consider the amount of money most people need to have to provide for a comfortable retirement, the loss of an income earning member of a relationship can be a massive blow to the other person’s ability to have enough in savings for retirement. Especially if a mortgage is involved, it is not easy to replace a lost person’s income (who dies while married) enough to pay for the current lifestyle of the family.
If children are involved, the need for life insurance is even more obvious. Children are expensive to house comfortably, be clothed appropriately, be fed adequate amounts of nutritious food, and be entertained, and they also have daunting education costs looming if they plan on attending college.
The loss of income from one partner can seriously hinder the ability of the other to have enough money to cover all of these child raising costs. Even if the partner lost did not work, they likely provide childcare. According to a New York Times article, the annual cost of childcare can reach $30,000. Over 10 years, that is $300,000 that must be spent on childcare, not including inflation. Life insurance can provide a comfortable future for children.
As discussed above, the birth of every child brings new expenses. Children, especially babies, depend upon income earning adult(s) to survive, and if that person or persons pass away a child will need a lot of money to provide for their needs and secure their future. Every new child means higher future expenses for the family.
This also means that more life insurance is needed to protect the children if something happens to a parent. According to an article by CNN, it now costs about $250,000 to raise a child, and this does not include college. A 4 year private education can cost upwards of $200,000 alone! This means that each new child brings a need for an additional $250,000 to $500,000 of life insurance for most families.
Luckily, term life insurance can be purchased for very low rates. This is especially true for new parents, who are usually young and healthy. A study by Life Ant just found that new parents, and in particular new young mothers, are woefully under-insured despite being the least expensive demographic to purchase coverage for.
Additional coverage can also be added to an existing life insurance policy if you buy a rider usually called a “guaranteed insurability rider”. This rider allows the owner to purchase additional coverage on the life of the insured without any additional underwriting or proof of insurability. This can be a less expensive way to add insurance coverage as needed after a policy has already been issued.
No matter which type of coverage is chosen, life insurance can play an important role in securing the future of children’s well being.
Life insurance is often bought when a mortgage is taken out. If a couple is married and shares the mortgage, it prevents the death of one person from leaving crippling debt for the remaining person. Many people would rather remain in their house, especially if they have children, after a partner passes away. Unfortunately, a mortgage can be a very difficult expense to keep up with on a single income. Purchasing life insurance when a mortgage is taken out provides a peace of mind to both partners that an early death will not ruin the credit and financial situation of the other person in the relationship. A house is the last thing that one wants to lose immediately after losing a loved one. Some lenders may even give preference to mortgage buyers who have life insurance, because they know that the loan will not default based upon a death.
There is a special kind of life insurance made specifically for the purpose of paying mortgage expenses after a death. The death benefit drops over time, to roughly correspond with the remaining balance of the mortgage. This is also called a modified face life insurance policy. This type of insurance can be purchased from any major life insurance company.
This type of mortgage life insurance policy is less expensive than a level face policy, and it accomplishes the goal of paying off the remaining mortgage balance at any point during the lifetime of the outstanding debt. An important feature of this is that the beneficiary of the policy is not required to be the bank, and the death benefit money can legally be used for any purpose by the beneficiary. It does not actually need to pay the mortgage if the beneficiary decides that there is a better use for the money. The death benefit is always theirs to do whatever they like, or whatever is most financial advantageous at the time.
Business and Investment Needs
Life insurance can be used to protect owners of a business, or the business itself, from the death of important people to the success of the business. Some of the ways that it provides this protection are through key man insurance, where a policy is purchased on the life of an important person within the business whose death would be a significant detriment to the business. Another important use for life insurance in business is for a partnership buyout agreement. If multiple partners have ownership in the business, the the remaining partners do not want to work with family members of another partner if he/she dies, life insurance can be purchased on each partners life, and the remaining partners are the beneficiaries. If a death occurs, they will use the proceeds to pay the family for their share of the deceased partners equity in the business.
Life insurance can also be used as an investment. This is mostly through the use of whole life insurance, where money is invested in the life insurance policy with the intent of growing the cash value through tax deferred dividend payments. Eventually the policy will have a positive return on investment for the owner, and this provides diversity to their overall investment portfolio while providing life insurance protection.
The purpose of life insurance is to mitigate the financial risk of someone passing away. There are many times in life where a financial risk will exist if someone dies, and life insurance is appropriate whenever that is the case. Marriage, childbirth, mortgage and business reasons are the most common events which require life insurance.