Building a family is an incredible responsibility. Since the dawn of time, parents have instinctively sought to provide for their children’s future, helping them to eventually become independent adults capable of functioning on their own. Practically speaking, life insurance can help parents protect their children against life’s uncertainties. For parents, here is what you need to know.
There are no guarantees in life, and therefore it is important for all of us to make contingency plans. This includes thinking about what would happen if you are no longer here.
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What Is Life Insurance?
Life insurance is a financial contract between you and a financial institution. In exchange for regular premium payments, the financial institution will agree to pay a death benefit to your beneficiaries if you die while the policy is in force.
There are different types of life insurance, with the two most common policies being term life and whole life. Term life insurance is valid for a specific period of time, generally 10-, 20-, and in 30-year increments. (Hence, the name term life insurance.)
Whole life insurance is a more complicated arrangement. It never expires, and has a cash value component that can be accessed by the policy holder during their lifetimes. It is also a much more expensive policy than term life insurance.
How Should Parents Calculate their Life Insurance?
For parents, the idea of life insurance can be simultaneously straightforward and incredibly complex.
On the one hand, it is very simple: You want to ensure that your children and those you have a responsibility for looking after can transition to life after you are no longer here. In that sense, you want to make sure that the death benefit is sufficiently large enough to take care of your outstanding obligations for years into the future.
On the other hand, it is exceptionally complex: How can you put a monetary figure on the value of your life? When it comes to term life insurance, there are a number of ways that people price their prospective death benefits, such as the DIME and 10x methods.
With the DIME approach, you would combine your current and future Debts, Income, Mortgage, and Education expenses. According to this calculus, you will arrive at your desired death payment by combining your debts, your salary and an assessment for how long your dependents will need this income, your mortgage obligations, and the expected future education costs for your dependents.
Many people also choose to simply take their current salary and multiply it by 10 to arrive at their desired death payment. This is known as the 10x Rule.
Once you have figured out your desired death benefit, you will work with a financial institution to reach an appropriate arrangement that will lead to payout of this amount.
What Is the Purpose of Life Insurance?
The purpose of life insurance is to protect your loved ones, allowing them to have some financial security after you die. That is all term life insurance is designed for.
Simply put, it was created to replace the income or value that you contribute to your family. Both the DIME and 10X approaches have this in mind, as the death benefits that they each provide will offset the costs of living that you will no longer be able to help with. When these term policies expire, the theory goes, your beneficiaries will be older and no longer need the acute, direct support that you were providing earlier in their lives.
Whole life insurance has a different set of factors, and those who purchase it are not solely looking to replace their income. There are often other tax, estate planning, and investment considerations at play, which extend well beyond the parameters of income replacement.
Term vs. Whole Life Insurance
For the vast majority of people, life insurance should be geared towards making sure that their family is taken care of after they die.
Your personal finances are about balancing between all of life’s trade-offs. And there are plenty. Between mortgage payments, retirement savings, education funds, and a litany of other expenses, there are numerous obligations that we all must allocate our limited income towards.
For most individuals, the decision to purchase term life insurance makes much more fiscal sense than whole life. It is significantly cheaper, but also provides the income replacement that parents are seeking for their dependents.
Whole life insurance, on the other hand, is much more costly. While it contains additional financial benefits, you must ask yourself how paying for the more expensive premiums fits into your monthly expenses. For many individuals, it simply is not worth the added cost.
Conclusion: Protecting Your Family
For parents, the responsibility to care for your children never truly ends. We want to do everything in our power to set them up for success, even after we are gone.
Life insurance–particularly term life insurance–is a financial arrangement that can help with the transition to their new lives in your absence. Of course, our sincere hope is that we outlive our term life insurance policy, and the death benefit becomes moot. Our life insurance will have just been used to provide us with peace of mind during the years that it was in force.
For most of us, our real goal is to live a financially responsible life, putting money aside for all our needs, along with a healthy balance of savings and investments. Eventually, when we do die, we will be able to pass down some wealth to our children and our descendants due to the smart decisions we made while we were alive.
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