Does my family really need life insurance?

One of the most common questions we receive from young families is whether they should purchase term life insurance or one of the many forms of permanent life insurance, such as whole life or universal life. It is an important question and unfortunately one that often receives an overly simplistic answer.

The reality is that every type of life insurance has a purpose. The challenge is determining which type of insurance best addresses the financial need you are trying to solve.

For most young families, that need is relatively straightforward. It is not creating wealth or leaving a legacy. It is replacing income if something unexpected happens.

When a family is raising children, paying a mortgage, saving for college and building retirement savings, the loss of one spouse's income can create an immediate financial hardship. In those situations, the primary purpose of life insurance is to provide enough money for the surviving spouse and children to continue pursuing the financial goals that were already in place.

That is exactly what term life insurance is designed to do.

What Is Term Life Insurance?

Term life insurance provides coverage for a specified period of time, often 10, 20, or 30 years. If the insured dies during the term, the policy pays a death benefit to the beneficiaries. If the coverage period ends and the policy is no longer needed, it simply expires.

Because it provides pure insurance protection without a savings or investment component, term life insurance is often significantly less expensive than permanent life insurance.

This allows young families to purchase much larger death benefits at a cost that fits comfortably within their budget.

Matching the Insurance to the Need

Consider a couple in their mid-30s with four young children (this couple sounds eerily familiar!).

They may have a mortgage, childcare/education expenses, college savings goals and decades of future income that their family depends upon. If one spouse were to pass away unexpectedly, replacing that lost income could require several million dollars.

For many families, term life insurance provides the ability to protect against that risk without requiring thousands of dollars in annual premiums.

As time passes, the family's need for life insurance often declines. The mortgage is gradually paid off. Children become financially independent. Retirement accounts grow. Investment portfolios increase. Eventually, the family may become financially independent enough that income replacement is no longer necessary.

In many cases, the need for insurance decreases as wealth increases.

Where Permanent Life Insurance Fits

This does not mean whole life or other forms of permanent life insurance are inappropriate.

Permanent insurance can play an important role in certain situations.

Individuals with large taxable estates may use permanent insurance to provide liquidity for estate taxes or wealth transfer planning. Business owners may use it to fund buy sell agreements or key employee arrangements. Others may value the guarantees, cash value accumulation or lifelong coverage that permanent policies provide.

These are legitimate planning objectives.

However, they are often very different from the needs of a young family simply trying to protect against the loss of future income.

Don't Let the Investment Drive the Insurance Decision

One of the reasons permanent insurance is frequently discussed is because many policies accumulate cash value over time. While this feature may provide benefits in certain circumstances, it should not distract from the primary question: What financial problem are you trying to solve?

If the goal is income replacement during your working years, purchasing a large amount of affordable term insurance while investing the difference elsewhere may often be a more efficient strategy.

This approach allows families to adequately protect themselves while continuing to maximize contributions to retirement accounts, emergency savings, college savings plans and taxable investment accounts.

For many young families, these priorities may have a greater long-term impact on financial independence than accumulating cash value inside an insurance policy.

Review Your Coverage as Life Changes

Life insurance is not a one-time decision.

Marriage, children, career changes, home purchases and growing wealth should all prompt a review of existing coverage.

Likewise, individuals approaching retirement often discover that their need for life insurance has changed dramatically. What was once essential for protecting income may no longer be necessary if the family has accumulated sufficient assets to support the surviving spouse.

Insurance should evolve as your financial life evolves.

Final Thoughts

Life insurance is one of the most important tools available for protecting a family's financial future. The key is selecting the type of coverage that best matches your specific needs.

For many young families, term life insurance provides an affordable way to replace income during the years it matters most. It allows parents to protect their children, their spouse and the financial goals they have worked hard to build.

Permanent life insurance certainly has its place in financial planning, particularly for estate planning, business succession and other specialized situations. But for someone who is young, has dependents and simply needs to protect their family's standard of living, term life insurance is often the most practical and cost-effective solution.

The best insurance policy is not necessarily the one with the most features. It is the one that solves the financial problem you actually have.

Reid Schwartz is a columnist for The Item and Co-Founder of Creech Schwartz Wealth Management in Sumter, SC, where he works as a financial advisor helping individuals, families, businesses, and nonprofits plan for long-term financial success.

*Tax and accountancy services are not available through or provided by Creech Schwartz Wealth Management or &Partners, LLC.

This article is for educational purposes only and not to be interpreted as tax or legal advice. Any tax planning strategies discussed by Creech Schwartz Wealth Management will be in conjunction with your tax/legal professional.

Securities and investment advisory services offered through &Partners, LLC, a broker-dealer and investment adviser registered with the U.S. Securities and Exchange Commission and member FINRA, SIPC.