By: Edward Leach, CFP®, MBA
You’ve worked hard to build a stable life for your loved ones, but are you taking the necessary steps to protect their financial future? Life insurance is a crucial tool that provides peace of mind, ensuring that your family won’t be burdened with financial worries if something happens to you. It’s an essential part of any comprehensive financial plan, whether it’s to support your family’s needs or to preserve the stability of a business.
This article will walk through key life insurance concepts everyone should understand. We’ll explain why life insurance is vital, clarify the difference between term and permanent policies, and debunk a common misconception about using life insurance as an investment. Additionally, we’ll touch on how buy-sell insurance can protect your business in an unexpected tragedy.
Why Do You Need Life Insurance?
If you have financial responsibilities—such as mortgage payments, debt, or simply supporting your family’s lifestyle—life insurance can provide a financial safety net in the event of your passing. Without life insurance, your family could be left scrambling to cover debts or maintain their standard of living.
Life insurance provides a death benefit that can help cover:
Outstanding debts like a mortgage or loans
Daily living expenses for your family
Future financial goals such as children’s education
Without this coverage, your family could face significant financial challenges, especially if you are the primary breadwinner. Life insurance ensures your loved ones are financially protected and have the necessary resources to continue without disruption.
Term vs. Permanent Life Insurance: What’s the Difference?
When choosing life insurance, you’ll generally select between term and permanent life insurance. Knowing the difference can help you choose the right policy for your needs.
Term Life Insurance: This is straightforward coverage that lasts for a set period—typically 10, 20, or 30 years. If something happens to you during that time, your beneficiaries receive a death benefit. Term life insurance is often more affordable and provides robust coverage during your prime working years when financial responsibilities like a mortgage, raising children, or debts are most significant.
Permanent Life Insurance: Permanent policies, such as whole life or universal life, provide lifelong coverage and include a cash value component that grows over time. While that might sound appealing, these policies have higher premiums and fees. Permanent insurance may be helpful for estate planning or wealth transfer, but for most people, term life insurance is a more cost-effective choice.
Which Option Is Right for You?
For most individuals, term life insurance is the best choice because it provides ample coverage at a much lower cost than permanent life insurance when needed most. Permanent life insurance may only be worth considering if you have complex estate planning needs.
Life Insurance Is not an investment, it is a transfer of risk for a premium
One of the biggest misconceptions about life insurance is that permanent policies can double as an investment. While these policies build cash value over time, they are ineffective in growing wealth. Here’s why:
Low Returns: The returns on the cash value of permanent life insurance policies are typically much lower than traditional investments like stocks, bonds, or retirement accounts.
Limited Liquidity: Accessing the cash value is often complicated and involves loans or withdrawals that reduce the death benefit.
Higher Costs: Permanent life insurance comes with significantly higher premiums than term policies, with most of the extra money going toward paying for the policy rather than building cash value.
If your goal is to build wealth or save for retirement, you’re better off focusing on traditional investments like a 401(k), IRA, or a diversified investment portfolio. Life insurance is best used for protection, not investment.
For Business Owners: Protecting Your Business with Buy-Sell Insurance
If you own a business, there’s another critical aspect of life insurance to consider—buy-sell insurance. This type of life insurance ensures that your business can continue operating if one of the partners dies unexpectedly.
Here’s how it works: A buy-sell agreement is funded by a life insurance policy taken out on each partner. If one partner dies, the death benefit is used to buy out their share of the business, ensuring the business can continue to operate smoothly without financial strain or conflicts with the deceased partner’s family. This type of insurance ensures a smooth transition and financial stability for the business.
Are You Protecting Your Family’s Future?
Life insurance is a vital part of a comprehensive financial plan. Whether it’s to provide for your family, pay off debt, or protect your business, having the right coverage can make all the difference. Term life insurance is often the best option for most people, but if you’re unsure about what’s best for your situation, don’t hesitate to seek advice from a financial professional.
Feel free to reach out if you want to learn more about the best life insurance options for your needs. Stay tuned for the next article in this series, where we’ll discuss the importance of disability insurance and how it plays a crucial role in securing your financial future.
Ed Leach, CFP®, MBA, is a Partner and Wealth Advisor at HIGHLAND Financial Advisors, LLC in Wayne, NJ, and works directly with clients advising them on their financial planning and investments. Ed’s work focuses on the unique needs of business owners, helping them extract value from their businesses while creating efficiencies in their business and personal financial plans. He is also a member of NAPFA, which is dedicated to serving fee-only advisors.