You Probably Don’t Need Life Insurance Forever

How long do you need life insurance for?

Life insurance is often an essential part of a family protection plan ‘in case of.’ Though there are many reasons to have life insurance, such as funding buy-sell agreements for business owners or liquidity to pay estate taxes, the primary reason most individuals purchase life insurance is to help ensure their children and/or spouse will be provided for financially in the event of their death.

But since kids eventually grow up and outside assets tend to accumulate over time, why do so many individuals feel they need life insurance for their entire life? Perhaps they never considered that they didn’t.

Stay true to your objectives

Life insurance policies are notoriously confusing, and unfortunately, the individuals who sell them don’t always help clarify.

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Ideally, before sitting down with a life insurance agent or licensed representative to discuss policy options, you have a solid understanding of the reason(s) you need coverage. For parents with young children, that often includes paying for college, regular expenses such as food and childcare, and paying off the mortgage. In one-income households or relationships with disparate incomes, each spouse will likely require a different amount of coverage to support the other.

Considering your needs and motivations for life insurance is a very important step to help ensure you get the right policy without being oversold. In some situations, the investment component of permanent life insurance is appropriate and advantageous. However, in others, the need for life insurance is strictly goal-based funding and liability matching. In these cases, the added cost of permanent life insurance and the investment features may not be justified.

How long do you need life insurance for?

It should come as no surprise that everyone’s needs will be different. Though there are no hard-and-fast rules, there are several questions that are often good to use as a starting point:

–         If you (or your partner) were to pass away, what would the impact be on your ability to meet regular expenses? It’s common that the surviving spouse will inherit other assets, such as an IRA, 401(k), or brokerage account. The availability of other assets should be factored into your need for outside insurance.

–         How many years until the kids are out of college and fully independent? If your college savings goals are already fully funded and your kids have been launched, this specific need might already be satisfied.

–         How many years are left on the mortgage? Liability matching is helpful when estimating life insurance needs, but also consider whether you or your spouse would wish to remain in the home at all.

–         Will your estate need liquidity? Illiquid assets, such as real estate or interests in a privately held business, can create problems for an estate if there’s insufficient cash to cover potential federal and/or state estate tax, pay off outstanding debts, and other related expenses. A life insurance policy can be used to pay for these costs in lieu of selling the assets.

–         Do you have unsatisfied legacy goals? Consider your estate plan and other financial assets to determine whether there’s still a need. Though proceeds from life insurance policies aren’t generally taxable to the beneficiary, the proceeds are included in the decedent’s gross estate, which could cause your entire estate to become taxable at the state or federal level.

Life insurance needs generally don’t just flip off like a light switch, but rather decline gradually over time. Depending on the type of policy you have, there may be ways to reduce your benefits as you move through different life stages, though it doesn’t always make sense from a cost-savings perspective.

What to do with your life insurance policy when you don’t need it anymore

If you no longer feel the need for your current policy, it may make sense to consider your options. Before taking any action, it is strongly advised that you discuss your entire financial situation with your financial advisor and insurance professional.

What options you may have available to you will depend on the type of insurance you have as well as any policy-specific provisions. For term life insurance, the policy can just be cancelled; no more premiums and no more insurance.

Permanent life insurance (whole, variable, or universal life) has two components: the face value (e.g. death benefit) and the cash value, which is essentially a savings account funded by a portion of your premium payments and potentially investment returns depending on the type of insurance. Though you’ll need to review your policy documents to determine what provisions apply to your situation, if you’ve had the policy for a number of years you can generally apply a portion of the accumulated cash value to cover premium payments or make a withdrawal to use for other financial goals or reinvest in the market. This strategy could keep your policy in force (though the death benefit might be significantly reduced) while giving you access to the cash value.

Another option is to cancel the policy and take the surrender value of the cash value. Keep in mind that a surrender charge may apply if you were to cancel the policy; sometimes these penalties are significant. There may also be tax implications if your cash value exceeds your premium payments.

Yet another possibility to consider is whether to explore converting the life insurance policy to long-term care insurance using a tax-free 1035 exchange. Not every policy is eligible and there are a host of other complexities to consider which will require the support of a specialist in this area.

If you have life insurance through your employer, it may make sense to keep the policy in force even if you don’t need it depending on whether the benefit is employer-paid or heavily subsidized.

It is very important to discuss your options and weigh the pros and cons with your financial advisor and insurance professional before cancelling your life insurance coverage or modifying your benefits. Health can change in an instant and it may not be possible (or financially feasible) to re-purchase insurance later.