The right insurance depends on needs

Q.My wife and I are 32 and have an 8-month-old daughter. We bought a house two years ago, and the payments fit comfortably into our budget. I earn $42,000 and my wife earns $37,000. We need life insurance, but aren’t sure how much or what kind. Can you help?

A.Young families often overlook the importance of life insurance in their financial plans. But it is one of the fundamental elements of a comprehensive risk management program. An emergency cash reserve and health and disability insurance are important elements, as well.

There are two kinds of life insurance, temporary and permanent. The amount and kind you buy should be based on your goals and circumstances. First, let’s consider the type of insurance.

Take a couple with young children, a mortgage and no retirement savings. They need life insurance in case a breadwinner dies before the children finish college, the mortgage is paid, and retirement savings are accumulated. And frankly, they need a lot of it to fund these needs.

These are temporary needs. The children will finish college. The mortgage will be paid. And savings will be accumulated for retirement. At that point, insurance will no longer be needed to meet these particular goals. Temporary needs are best met with “term” insurance, which is relatively inexpensive per thousand dollars of coverage.

Now, take an older couple with two adult children. One child is active in the family business and one is not. The family business is their primary asset and they want to treat their children equally in terms of inheritance. But they don’t want to tie them together financially. They need life insurance to provide an equal inheritance for the child who is not active in the family business.

This is a permanent need. Ultimately, the couple will die and the inheritances must be equalized. Permanent needs are best met with a form of “cash value” insurance, including traditional whole life, variable whole life, universal life, variable universal life, and so on. The different forms of cash value insurance have different risk and return characteristics, and costs. In general, it is more expensive than term insurance, which may make it difficult (if not impossible) for a young couple to buy enough cash value insurance to meet their needs.

Now, let’s consider how much life insurance you need. There are many ways to calculate this. For example, you might calculate the present value of your lifetime earnings. Or you might deduct from the present value for income taxes (death benefits are tax-free), Social Security survivor benefits and other factors. Or you might calculate the amount based on specific needs, such as paying for college or the mortgage, living expenses and a retirement fund.

Based on the limited information you’ve provided, it seems likely that term insurance will be a good choice for you and your wife. But we recommend working with a certified financial planner to determine this and how much life insurance you need.