Life Insurance - Why is it important?
Buying life insurance protects your spouse and children from the potentially devastating financial losses that could result if something happened to you. Life insurance can pay your funeral and burial costs, probate and other estate administration costs, debts and medical expenses not covered by health insurance.
1. Financial Protection
Life insurance is meant to help protect your family's financial future. Buying a life insurance policy helps protect your family's financial stability in the event you pass and could help mitigate the stress and burden of an already difficult time. Even if you have savings, it's unlikely that it would be enough to cover your family's expenses for several years or even decades if something happens to you unexpectedly.
Typically, there are three types of life insurance options to consider: term life, whole life or universal life. Death benefits are typically paid in a lump sum payment. This money can be used to cover expenses like medical bills, funeral costs, outstanding debts, mortgage payments and tuition.
Certain types of debt don't go away when you die, which means your loved ones may have to use money from your estate or sell off other assets to cover them. This could leave less money to pay for expenses. At a time when your loved ones are already dealing with your loss, life insurance can help ease some of the financial burdens they may experience after your passing and help provide a financial safety net.
2. Income Replacement
Whether you have a 9-to-5 job, are self-employed or own a small business, your current income might cover a portion or even all your family's daily needs. Housing, food, utilities, clothing, car maintenance, outstanding loans and health care premiums are likely all part of your monthly budget.
If you were to die unexpectedly, Your family will still need to cover these ongoing household expenses even without your income. According to the 2022 Insurance Barometer Study, 44% responded that it would take less than six months to experience financial hardship if the primary wage earner passed away. The life insurance death benefit can help replace the primary breadwinner’s income and ensure financial stability for your loved ones after you are no longer there to provide for them.
3. Access to Cash
Some types of life insurance —like Whole Life and Universal Life — offer you the added benefit of cash value. As you pay your life insurance policy premiums, the life insurance company invests this money, allowing you to build a cash value in the policy over time.
In the future, this cash value can be available to you through policy loans and withdrawals to take care of temporary financial needs or unexpected expenses, like a major car repair. Keep in mind, however, that withdrawing funds from your cash value will reduce the amount of your future death benefit, affecting how much money your beneficiaries would receive upon your death.
Building cash value in a permanent life insurance policy is one way to create an extra emergency fund, offering you additional financial security knowing that you can withdraw or borrow your cash value whenever you need to.
4. Financial Stability
One of the most important benefits of life insurance is that it can help provide greater peace of mind, knowing that your loved ones will be taken care of in case of untimely death. For example, Funerals can be expensive. Dealing with this financial stress can add to the emotional strain your family might experience.
Your family could use some of the death benefit from your life insurance policy to help pay for these funeral costs. The policy's beneficiary could direct some of the death benefits to the funeral home for final expenses, or they can pay out-of-pocket and use the death benefit as reimbursement for these expenses. You may rest easier by feeling secure in the knowledge that your family won’t face financial hardship by relying on the death benefit that life insurance provides.
5. Legacy Planning
Many people choose to use life insurance to leave a legacy for their loved ones or their favorite charitable cause. When selecting your life insurance beneficiary, consider to whom or what you want to leave your death benefit. For example, if you have children, life insurance can help your family pay for future childcare and education expenses, especially for college tuition. Even if you've already started contributing to a 529 College Savings Plan the death benefit from a life insurance policy can provide additional money to help cover your children's education if you were to die.
You also may choose to leave a legacy by charity giving by naming a religious, arts or charitable organization as your beneficiary. In addition, you may decide to donate your life insurance policy directly to the charity or allow the charity to purchase a policy on your life and make annual tax-deductible contributions to the charity to cover the policy’s premiums.
6. Supplemental Retirement Income
Life insurance also can be used to supplement your retirement income in a couple of ways. Permanent life insurance (either whole life or universal life) allows you to build up cash value, which you can borrow against and use as a supplemental source of retirement income. You also have the option to use the cash value from your policy to buy an annuity, allowing you to contribute money in a tax-deferred account that can distribute regular payments to you as an ongoing stream of retirement income.
7. Health Benefits
Life insurance riders, which can offer you important health benefits, are options that allow you to personalize your insurance coverage. Various riders can provide you with financial support in case of serious illness or disability or the need for long-term care. These additional protections, however, will increase your premium in many cases.
Some common life insurance riders include waiver of premium, accelerated death benefit, critical illness and long-term care. With a waiver of premium, your life insurance policy will not lapse for a certain amount of time if you are unable to pay your premium because you become disabled and unable to work due to an injury or illness. An accelerated death benefit rider —also known as a terminal illness rider — can pay out a portion of the policy’s death benefit before you die if you have less than 12 to 24 months to live (time frames may vary, depending on the policy). Critical or chronic illness riders allow you to access your death benefit while you are living if you are diagnosed with a qualifying health condition as defined by the policy. If you are concerned about the need for long-term care in the future, a long-term care rider may allow you to use part or all your policy’s death benefit for long-term care while you are alive.
8. Estate Planning
Another reason why life insurance is important for your loved ones is related to estate planning. You can use life insurance as an estate planning tool to help plan for your heirs to have sufficient liquidity (i.e., cash on hand) after you die to pay any necessary estate taxes and final expenses. Because liquidating estate assets is time-consuming, the death benefit from life insurance can be used for faster payouts to cover funeral and burial costs, medical bills, and outstanding debts and taxes. It can also help to equalize estate inheritance if one heir receives real estate, and another heir receives cash.
As the owner of a life insurance policy, you can decide how the death benefit should be used. People can use life insurance death benefits for a variety of estate planning purposes: to continue financially supporting an aging parent or a child with a disability, paying alimony or making child support payments. Proceeds from life insurance can also fund a trust for another purpose.
9. Reduction of Taxes
Life insurance policies can offer certain tax advantages. First, the death benefit is generally paid out to your beneficiary free of income tax. Consequently, a sizeable death benefit will avoid a hefty payment of income tax. By contrast, most retirement plan proceeds received by beneficiaries will typically be taxed by the IRS. And while life insurance death benefits are generally exempt from income tax, they are not generally exempt from federal estate tax. However, you can establish an irrevocable life insurance trust (ILIT), which can exclude life insurance proceeds from the taxable estate and transfer the death benefit immediately to beneficiaries.