While we might not like to think about death, it’s a reality for everybody. And sometimes, it comes too early, causing financial hardship in addition to emotional pain. Life insurance can help with the financial impact of death, but people often don’t understand how it works and how much it costs.
In many cases, life insurance is relatively inexpensive and provides crucial protection for loved ones.
How Life Insurance Works
Life insurance provides a large payment to beneficiaries when an insured person dies. The payout might be hundreds of thousands of dollars (or more), and that money is often free from federal income taxes. To get coverage, you submit an application, which typically involves answering health questions and may include a brief medical examination. Then, if approved, you pay premiums to a life insurance company in exchange for coverage.
Some forms of life insurance, such as guaranteed issue life insurance, do not require a medical exam or health questions.
Life insurance comes in several forms; you can categorize them broadly as term insurance and permanent, or cash value, insurance. Term insurance is the simplest and least expensive form of life insurance, and it’s an excellent choice for most families protecting themselves from the untimely death of a family member. With term insurance, you select a term (20 or 30 years, for example), and insurance coverage ends after that time.
Why Life Insurance Is Important
Life insurance provides much-needed funding when tragedy strikes, and being underinsured can be extremely risky. Some of the most common reasons to have life insurance include the following.
To Protect Dependents
If a spouse, children, or other loved ones depend on you, there’s a good chance you need life insurance. If you’re a wage-earner in the family, your death would leave dependents without a vital source of income. The result could be a domino effect of financial hardships that last for years. This is because lost income makes it hard to save for goals like education, which can mean children enter the workforce with heavy student debt. It’s also much more difficult to save for retirement if a spouse or partner has to support a family on their own.
Even if a family member does not earn an income, their death can have significant financial consequences. For example, the loss of a caregiving parent might require that the surviving parent hire others for caregiving, spend more time on household duties, or quit working altogether.
To Pay for Funeral Costs
When somebody dies, there may be several expenses related to their death. In addition to any medical bills, you may incur final expenses, such as paying for a funeral, memorial, cremation, and more.
The national median cost of a funeral with burial is $7,640. If you choose cremation instead of burial, the cost is roughly $5,150. That may be a substantial and unexpected bill for anybody coping with the loss of a loved one. Life insurance can help cover those costs and ensure that survivors arrange a memorial that’s meaningful for them.
To Pay Off Debts
Life insurance proceeds can pay off debts that might otherwise leave your loved ones in a difficult position. Being debt-free provides significant relief if the household income drops or expenses rise from caregiving needs. Even if you don’t have family members depending on you, anyone who co-signed a loan for you will be responsible for your debts. Life insurance can prevent their good deed from becoming a burden.
Paying off debt after death is complicated. Depending on state law and how you borrow, a surviving spouse might be responsible for your debt. Check with an attorney licensed in your state to learn what to expect after death and how to best prepare for it.
To Protect Your Business
The death of a key employee or business owner can cause financial problems for your business, which is why many organizations use life insurance to manage risk. If the person who dies is responsible for business development, sales may fall sharply after their death. Or if you need to hire help quickly to fill a crucial role, you might need cash to pay recruiters, a signing bonus, and the first several months of salary.
Although key person life insurance is an expense for your business, it might not be deductible. Speak with your CPA before making any decisions or counting on a deduction.
Why Buy Life Insurance if You’re Young and Healthy
If you’re not worried about dying—and nobody depends on you financially—it could still make sense to buy life insurance. The cost of insurance rises as you get older, so locking in a low rate can be beneficial.
The table below shows sample monthly premiums for a 20-year term insurance policy (assuming a nonsmoker with average health). As you can see, the older you get, the more you pay for insurance.
|Gender||Age||Death Benefit||Monthly Premium|
Waiting can also be problematic if you develop health problems (or discover previously unknown issues) as you age. Insurance companies charge higher rates or deny coverage if you have certain conditions, so buying when you’re young and healthy can help you avoid those issues.
How Much Life Insurance Do You Need?
There’s no way to know exactly how much money survivors will need. One way to arrive at a reasonable estimate, is to determine which expenses your dependents will need to pay, and for how long.
Survivors need to pay for housing and food, among other expenses, and it’s nice to include a budget for “wants” as well as those needs. Ideally, the funds should also help loved ones save for financial goals like retirement or education costs. And it may be helpful to pay off debts (such as a home mortgage, auto loans, and student debt) or provide enough money to fund monthly payments for an extended period.
A simplified approach is to use a multiple of your salary. For example, you might buy a death benefit equal to 10 times your annual salary—and add $100,000 for each child’s education expenses. That method may ignore important issues, but it’s a popular way to estimate insurance needs, and it’s probably better than doing nothing.
When You Don’t Need Life Insurance
Some people don’t need life insurance. If your death would not cause any level of financial hardship for anyone, you might not need coverage. For example, this could be the case if your children are grown and self-sufficient, and you have accumulated more than enough assets to provide for a surviving spouse and anyone else who depends on you.
Most people are not financially independent, however. If you have a family—especially a young or growing family—it’s smart to explore your options before ruling out life insurance. The risk of leaving anybody in a bind is too great, and the results can be devastating.
- Life insurance can provide a large payout when an insured person dies.
- Proceeds from life insurance are tax-free and can pay off debts, replace income, and cover final expenses.
- Life insurance costs are at their lowest when you’re young and healthy.
- It’s wise to consider who might suffer financially (and what resources might help them) after death.
National Funeral Directors Association. "NFDA General Price List Study Shows Funeral Costs Not Rising as Fast as Rate of Inflation." Accessed Jan. 22, 2021.
IRS. "Publication 535 (2019), Business Expenses." Accessed Jan. 22, 2021.
Term4Sale. "Term Life Insurance Quotes." Accessed Jan. 22, 2021.