Minnesota Insurance Rate

Life Insurance

If you have dependents or other people with whom you share your life, life insurance can play a vital and valuable role at virtually every stage of your life. It’s not just for the young, nor is it only for parents or guardians of young children.

Why buy life insurance? The main reason for insuring your life is to replace an income you are generating that someone else relies on. The most common case is a one- or two-earner family with young children. If an earner dies, life insurance can enable the survivors to go on without having to make financial sacrifices.

Life insurance can also pay for one-time costs that are connected with death, such as funeral and burial costs, administration costs (e.g., for probate and transferring title to property to the heirs), estate and inheritance taxes, and outstanding debts (such as final medical expenses not covered by health insurance). There are several other reasons to buy life insurance as well.

You have to make many choices when buying life insurance: how much to buy, which type of product to buy; and which one of the hundreds of life insurance companies to choose. Even if you “shop” online, it is in your interest to work with a knowledgeable professional who can understand your needs and constraints, answer your questions, and help you find the most appropriate solutions.

Why should I buy life insurance?

  Many financial experts consider life insurance to be the cornerstone of sound financial planning. It can be an important tool in the following situations:

  1. Replace income for dependents
    If people depend on your income, life insurance can replace that income for them if you die. The most commonly recognized case of this is parents with young children. However, it can also apply to couples in which the survivor would be financially stricken by the income lost through the death of a partner, and to dependent adults, such as parents, siblings or adult children who continue to rely on you financially. Insurance to replace your income can be especially useful if the government- or employer-sponsored benefits of your surviving spouse or domestic partner will be reduced after your death.

  2. Pay final expenses
    Life insurance can pay your funeral and burial costs, probate and other estate administration costs, debts and medical expenses not covered by health insurance.

  3. Create an inheritance for your heirs
    Even if you have no other assets to pass to your heirs, you can create an inheritance by buying a life insurance policy and naming them as beneficiaries.

  4. Pay federal “death” taxes and state “death” taxes
    Life insurance benefits can pay estate taxes so that your heirs will not have to liquidate other assets or take a smaller inheritance. Changes in the federal “death” tax rules between now and January 1, 2011 will likely lessen the impact of this tax on some people, but some states are offsetting those federal decreases with increases in their state-level “death” taxes.

  5. Make significant charitable contributions
    By making a charity the beneficiary of your life insurance, you can make a much larger contribution than if you donated the cash equivalent of the policy’s premiums.

  6. Create a source of savings
    Some types of life insurance create a cash value that, if not paid out as a death benefit, can be borrowed or withdrawn on the owner’s request. Since most people make paying their life insurance policy premiums a high priority, buying a cash-value type policy can create a kind of “forced” savings plan. Furthermore, the interest credited is tax deferred (and tax exempt if the money is paid as a death claim).

 

How much life insurance do I need?

  In most cases, if you have no dependents and have enough money to pay your final expenses, you don’t need any life insurance.

However, if you want to create an inheritance or make a charitable contribution, you should buy enough life insurance to achieve those goals.

If you have dependents, you should buy enough life insurance so that, when combined with other sources of income, it will replace the income you now generate for them, plus enough to offset any additional expenses they will incur replacing services you currently provide (for example, if you do the taxes for your family, the survivors might have to hire a professional tax preparer). Also, your family might need extra money to make some changes after you die. For example, they may want to relocate, or your spouse may need to go back to school to be in a better position to help support the family.

Most families have some sources of post-death income besides life insurance. The most common source is Social Security survivors’ benefits. Many also have life insurance through an employer plan, and some from other affiliations, such as an association they belong to or a credit card. Although these sources might provide a significant income, it is rarely enough.

A multiple of salary?

Many pundits recommend buying life insurance equal to a multiple of your salary. For example, one advice columnist recommends buying insurance equal to 20 times your salary before taxes. She chose 20 because, if the benefit is invested in bonds that pay 5 percent interest, it would produce an amount equal to your salary at death, so the survivors could live off the interest and wouldn’t have to “invade” the principal.

However, this simplistic formula implicitly assumes no inflation and that one could assemble a bond portfolio that, after expenses, would provide a 5 percent interest stream every year. But assuming inflation is 3 percent per year, the purchasing power of a gross income of $50,000 would drop to about $38,300 in the 10th year. To avoid this income drop-off, the survivors would have to tap into the principal each year. And if they did, they’d run out of money in the 16th year.

The “multiple of salary” approach also ignores other sources of income, such as Social Security survivors’ benefits. These benefits can be substantial. For example, for a person who had been earning a $36,000 salary at death ($3000 a month), maximum Social Security survivors’ monthly income benefits for a spouse and two children under age 18 could be about $2,300 per month, and this amount would increase each year to match inflation. (It drops when there is only a spouse and one child under 18, and stops completely when there are no children under 18 remaining in the household. Also, the surviving spouse’s benefit would be reduced if the spouse earns income over a certain limit.)

In this example, the survivors would need life insurance to replace only $700 per month (adjusted for inflation) of lost income; Social Security would provide the rest. These survivors would need life insurance to replace about $1,150 per month (adjusted for inflation) once the nonworking surviving spouse has only one child under 18 in her care, and the surviving nonworking spouse would have to replace the entire $3,000 (adjusted for inflation) when the youngest child turns 18.

 

Source: Insurance Information Institute www.iii.org

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