September is National Life Insurance Month! To “celebrate,” we’re helping you determine if you have enough life insurance coverage to protect your family.
The financial lives of medical professionals tend to be complex, and many doctors are the primary earners for their families. So, life insurance plays a vital role in protecting your family’s financial well-being in the event of an unexpected loss.
Here are the top things you to know about life insurance, including how to determine the right amount.
What’s Life Insurance (and Why Have It)?
Life insurance aims to protect your loved ones and anyone who depends on you financially if you pass away. No one likes to think about an early or unexpected death in the family, but neglecting to prepare doesn’t mean it won’t happen.
If your spouse and children depend on your income to put a roof over their heads and food on the table, how would they fare if you didn’t make it home tomorrow? Even a substantial emergency fund will only go so far.
Life insurance provides the safety net that keeps your family financially stable after your passing. Essentially, it’s there to replace your current and future income.
The first step in getting protected is knowing the importance of life insurance. But estimating how much you need is challenging. If you purchase too much coverage, you might be overpaying on premiums that you could use to support other goals. But too little coverage and your loved ones might not have enough to maintain their current lifestyles.
So, let’s dive into more details to help you navigate how much life insurance you need.
First, Does a Term or Permanent Policy Make More Sense?
There are two broad categories of life insurance: term and whole/permanent life insurance.
Term Life Insurance
A term life insurance policy covers you for a set period, typically 10, 20, 30, or 40 years. Once the policy hits its expiration date, coverage ends. Term policies are affordable, and many new-to-practice and seasoned doctors benefit from them.
Here’s an example of how a term life insurance policy may benefit you:
Say you have a spouse and a six-year-old at home who depend on your income. Aside from the mortgage, private student loan repayments (federal are forgiven at death), and a car loan, it’s important to you that all childcare expenses and college costs are covered.
Because of these goals, you might select a 20-year term policy as when it ends, you expect to have paid off most of your loans, your child is grown and living independently, and you’ve accrued a significant nest egg.
A term policy provides coverage when you need it most, not forever.
Laddering Your Term Life Insurance
Generally, as with any life insurance policy, the longer you wait to obtain one, the more expensive it will be. Premium costs can rise the older you get, especially if you develop certain conditions like diabetes, high blood pressure, heart disease, and other health concerns.
If you anticipate your coverage needs fluctuating but want to lock in a lower price for premiums, consider laddering your term life insurance policies.
“Laddering” refers to staggering the purchase of multiple policies, so each has a different end date. When the first policy ends, the others still cover you. Eventually, the policies taper off until you no longer need the coverage.
Whole or Permanent Life Insurance
Whole life insurance policies have no expiration date. They are designed to cover you for life. Naturally, this means premiums are most costly than term.
A key differentiator is that permanent life insurance policies accrue a cash value over time, and some policyholders choose to use it as an investment vehicle. After some time, usually 10 or 20 years, you have the option to borrow against your policy or surrender it for a lump sum.
Whole Life Insurance and Taxes
However, borrowing from or surrendering your life insurance policy may trigger a taxable event, so you should consider it carefully. As you pay your premiums, a portion of those payments goes into a cash-value account. This account continues to grow tax-free through interest accrued or investment gains, depending on the type.
The money added to the account through your premium payments is known as the “policy basis.” You can withdraw or borrow up to the policy basis without paying taxes. But any amount above the policy basis (i.e., accrued interest or investment gains) is subject to income tax.
Similarly, if you surrender your policy, you are responsible for paying income tax on gains above the policy basis.
Whole life insurance policies are complex, and you should review the details carefully with a financial professional before committing to one. In many cases, we’ve seen doctors benefit from buying a term policy and putting the difference in premium costs toward another investment like retirement savings or brokerage accounts.
How Much Life Insurance Do You Need?
Here’s a guide to determining how much life insurance coverage could be right for you and your family.
Get a Holistic Sense Of Your Financial Picture
Consider all aspects of your current financial picture:
- Income: How much you’d want to replace and for how long
- Present debts: Mortgage, car loans, student debt, personal loans
- Future debts: College expenses, childcare, funeral costs
Once you have a general sense of your finances, you can generate a more accurate number. As we mentioned earlier, your life insurance needs will likely change as you age, so it could be wise to look for a policy you can change or add to as needed.
If you’re a younger family with small kids at home, you likely require more life insurance than an older couple because more people rely on your income to survive.
Now that you have an approximate number to work with, here’s a good rule of thumb for determining how much life insurance is necessary.
Start by Multiplying Your Income By 10 (Then Keep Adding)
The method we’re presenting seems relatively simple, and that’s because it is! It’s not comprehensive, but it’s good for finding your starting point.
Begin by multiplying your current income by 10. If you earn around $200,000 annually, you’re looking at a policy that provides a minimum of $2 million in coverage. But is that enough to address your family’s needs? Not necessarily.
Factor in additional expenses that you’re anticipating down the road. Childcare costs, college tuition, a child’s future wedding, or lost income due to your spouse taking time off work or leaving the workforce entirely.
Your financial picture is multifaceted, and it’s essential to consider all aspects when determining how much coverage is needed.
By working with a financial professional while going through this process, you can address questions like:
- Will my spouse need to find a new healthcare plan if I pass?
- What costs will go up for my surviving spouse after I die?
- What insurance coverages do I already have in place?
- For how many years will my family have to replace my income?
- How can I take inflation into account?
Life Insurance Is Part Of Your Holistic Financial Plan
Comprehensive financial planning is about more than just helping you build wealth to reach your goals. It’s also about properly preserving your wealth. Life insurance is one tool to financially protect your family and loved ones should something unexpected happen to you.
If you have questions about your current policies, don’t hesitate to contact our team. We’d be happy to look at your protection plan and identify potential areas for improvement.
Partners in Financial Planning provides tax-focused, comprehensive, fee-only financial planning and investment management services. With locations in Salem, Virginia and Charleston, South Carolina, our team is well-equipped to serve clients both locally and nationally with over 100 years of combined experience and knowledge in financial services.
To learn more, visit https://partnersinfinancialplanning.com