Your death could result in a significant financial burden for anyone who relies on you to pay payments. This is when life insurance can be beneficial.
Using life insurance to replace your income can provide your beneficiaries with funds to pay expenses after your death while also giving you peace of mind.Â
Find out more about the life insurance income replacement technique and how to calculate your coverage amount.
Why it’s important to have life insurance to replace your income
The loss of a breadwinner’s income can be devastating for a family, and many people do not have adequate funds to absorb such an occurrence. According to the 2022 Insurance Barometer Study by LIMRA and Life Happens, nonprofit insurance trade associations, 44% of American households would experience financial hardship if the major wage worker died after six months.
Life insurance, like many other insurance products, protects against the unexpected. A life insurance payout is often made straight to your beneficiaries, who can use it to meet ongoing expenses in your absence. There are few exceptions, such as when the beneficiary is a minor and the life insurance death benefit is given to a guardian.
Even if you are not the primary earner, loved ones may rely on the services you give — and income replacement can assist them in covering those costs in your absence. Whether you’re a stay-at-home parent, one of several earners in your household, or the primary breadwinner, a life insurance policy can provide financial stability for those you leave behind.
What type of life insurance can replace your income?
In general, life insurance is classified into two types: term life and permanent life.
Term life insurance is for a specific period of time, such as 10, 20, or 30 years. It is usually the lowest level of coverage and is adequate for most families. You can tailor the term policy duration to the length of time you require coverage. For example, a 20-year term life policy might cover your income while your children are still at home, whereas a 30-year policy could cover your income for the majority of your working years. If you die while your policy is active, your life insurance beneficiaries will get the death benefit. Ideally, at the end of the term, your loved ones should be self-sufficient, and you will no longer require coverage.
To compare, a permanent policy, such as whole life insurance, pays out up to a certain age, usually 90 to 120, and normally accumulates cash value. Permanent life insurance is often more expensive than term life insurance because it covers you for the rest of your life. According to Quotacy, a brokerage firm, the average yearly premium for a 20-year, $500,000 term life policy for a 30-year-old woman is $189. For the same client, the average annual premium for a $500,000 whole life policy is $4,015.
If you’re merely buying a policy to replace your income, you might not need permanent life insurance. Those who rely on you today may be financially stable by the time you retire, rendering everlasting coverage unnecessary.
How to calculate income replacement
When determining how much life insurance you require to replace your income, one guideline is to multiply your annual pay by the number of years you wish to cover. For example, if your annual salary is $60,000 and you want to provide your beneficiaries with five years of coverage, you will need a $300,000 policy. Keep in mind that this simply shows your base wage. You should also budget for any expected raises and increased expenses, such as college fees.
You may have heard the “10 times income” guideline online, but there are no hard and fast rules for calculating coverage. If you want further information on how much coverage to get, go to a fee-only advisor. These consultants do not receive commissions from insurance companies, so they are not biased by the quantity of coverage you purchase.
Include daily tasks in your calculations
Consider the value of daily tasks when calculating your coverage amount. Any free child care, cleaning, and cooking you provide may be costly to replace if you die. For example, Care.com, an online marketplace for family services, determined that the average weekly cost of a nanny in the United States is $694 in 2021. Care.com also reports that a house cleaner normally costs between $16.25 and $21.25 per hour, depending on wage rates in 20 cities throughout the country. If you’re a stay-at-home parent, you probably do these things for free, and replacing them would be expensive. A life insurance policy might help cover the cost of these services in your absence.
Take into account any workplace coverage
If you have group life insurance via your employer, you should consider including the additional coverage amount in your calculations. However, keep in mind that these policies are sometimes linked to your employer, so you may lose coverage if you leave.
Reevaluate coverage if your income changes
It is critical to reassess your life insurance needs whenever your employment, income, or family situation changes. You may wish to purchase more than one life insurance policy to supplement your current coverage. Alternatively, you may choose to change your coverage if you become the sole breadwinner or if your expenses rise or fall.
Important: The ability to increase or decrease the death benefit amount may be dependent on the insurer. If you believe you will need to update your coverage over time, ask the insurer about modification possibilities before purchasing.
The main goal of life insurance is to replace your income. Here are four more popular reasons for purchasing coverage.
- Using life insurance to repay debt
- Using burial insurance to cover final costs.
- Purchasing life insurance as an investment.
- Using life insurance to leave an inheritance.
- Purchasing life insurance as a homeowner to aid with mortgage payments
