One of the costliest risks that families face is the death of a breadwinner (worker). This is especially true if a spouse and/or children depend upon that person for all or part of their support. To protect family members against financial disaster, consider the purchase of life insurance.
There is no simple formula to determine the amount of life insurance you need. Many factors must be considered, including:
current assets and current liabilities
earning power of surviving family members
other sources of income to the family
projected expenses and family support
Carry too little insurance and you may not provide a reasonable living for your family after death. Carry too much and you may not enjoy a reasonable level of living while you're alive. Many insurance companies have worksheets to calculate life insurance needs. They total up a family's economic needs and subtract available resources.
Worksheets generally include a total for lump sum cash needs such as mortgage liquidation, debt repayment, and final expenses. There are also calculations for the income needs of children and a surviving spouse. After the total amount of money needed is calculated, existing insurance and assets are subtracted to determine the additional amount of insurance required.
Once you have calculated the amount of coverage that you need, choose an insurance product that is right for you. There are two basic types of coverage which, in one form or another, are the basis for virtually all forms of life insurance. The two basic types are term insurance and permanent (cash value) insurance.
Term insurance, simply stated, is insurance that provides protection only for a specific period of time--this period of time is called the term. Term insurance has no cash value or investment value. Term insurance is one of the best ways to solve an insurance need having a short or limited duration (e.g., the years when children are dependents). It generally also has the lowest up front premium cost.
Term insurance offers a specific amount of protection for a given period of time. Each time the policy is renewed, the premium increases to reflect the additional risk as an insured person ages. Some types of term insurance, called level term, may have premiums which only increase every five or ten years or stay level for a certain number of years or until a given age. The longer the time of the guaranteed premium, the higher the initial premium will be.
Decreasing term was developed for people having an insurance need which becomes smaller over time. It is most commonly used when there's a declining degree of financial responsibility, such as a home mortgage. With decreasing term insurance, the level of protection declines over time, but the premium remains constant.
Permanent life insurance combines protection for the entire life of the insured person along with a savings component known as the cash value. Annual premiums are fixed for the life of the policy and are based on assumptions about interest and mortality rates. These premiums may be payable for life or for a limited number of years. Common forms of cash value life insurance include whole life, variable life, and universal life. The main difference between these different forms is in the method of cash value buildup.