Parents with young children and not a lot of financial resources probably have the greatest need for life insurance. It is just as important for a stay-at-home parent as it is for a wage earner. My rule of thumb if you have children is that you should have a minimum of $500,000 to $1,000,000 of life insurance.
This may seem ridiculously high, until you start crunching some numbers to figure out just how much it costs to raise a child as a single parent. Especially when you include possible expenses like maid service, daycare, orthodontia, and college tuition, $500,000 doesn’t seem like such a huge sum after all.
What makes this level of coverage affordable for young parents is term life insurance. Term insurance, as its name implies, is a policy taken out for a specific length of time, from five to 25 or 30 years. It pays your beneficiary the face amount upon your death. It is insurance only; there is no investment component or accumulated cash value associated with it. It is an expense, not an investment, just like homeowners or auto insurance.
If you are in good health, term insurance is typically inexpensive and adequate for most people. A male aged 32 who is a non-smoker with no health problems could buy a $1,000,000, 20-year policy for about $40 to $60 a month. A $500,000 policy would cost about $25 to $35 a month. The longer the term of the policy, the higher the premium.
The largest risk with a term policy is that you may become uninsurable and therefore unable to renew the policy at the end of the term. This is a legitimate concern, but it can be minimized by purchasing the longest term policy available. Typically, a 20- to 30-year term is long enough to ensure that children are raised and educated.
I recently heard from a reader who had been searching the Internet and found conflicting advice about the best type of life insurance to buy. Personal finance authors and speakers Dave Ramsey and Suze Orman strongly recommend term insurance. Other sources this reader had found said big companies and executives invested in cash value as part of their portfolios.
For most people, I’m with Dave and Suze on this one. I advise most of my clients to buy term insurance. If executives have cash value policies, it is usually because their companies are paying the premiums. Such policies, which are also called universal or variable life policies, include an investment feature, and they have much higher premiums.
While there may be some circumstances when cash value policies make sense, they are few and far between. Such policies might be appropriate as part of certain estate-planning strategies, generally for people with high net worth. They may serve to fund an irrevocable life insurance trust upon the second spouse’s death or to pay estate taxes on an illiquid estate such as a family business.
For anyone needing life insurance simply to provide for family members, however, term insurance is usually the best choice. It offers the most income replacement for the lowest cost.
The bottom line is that most people need a lot of life insurance to replace a lifetime of income, not as a way to produce income. Term insurance serves that purpose. To produce income, fully fund your retirement plan options with the money you save on premiums.