A Must for Your Baby Budget
Infant car seat? Check! Breast pump? Check! Collapsible stroller? Check! No doubt you’ve been anticipating your baby’s needs with much joy and making lots of purchases in advance of your little one’s arrival. But there’s one purchase you may not have considered. It’s an investment no parent relishes because it makes us think about the unthinkable. I’m talking about life insurance. It’s your baby’s safety net should tragedy strike. It’s a critical responsibility you truly owe your little one (or ones) to take on. It can also be part of a smart financial plan, that can benefit you while you’re living. So let’s learn a little more about it. Having a basic understanding of how life insurance works can help you choose the best policy life insurance policy for your family.
Life Insurance Basics
Life insurance policies fall into two general categories: term life and whole life. There are several differences between the two, but here’s what they have in common.
Both term and whole life insurance come with premiums and policy limits. Both pay a cash benefit when the policyholder dies. Who gets the money? The person or people you name as your beneficiaries. You may decide to name each of your kids as a beneficiary. Some moms decide to name a surviving parent as their policy beneficiaries, recognizing that a child is not in a position to decide how money should be spent on his or her behalf. But that may not be a great idea. Parental relationships change. And sometimes, sadly, both parents perish at the same time. If you name your children as beneficiaries, it’s important to stipulate, such as in your legal will, who will administer the funds your kids receive from your life insurance policy.
That’s pretty much where the similarities between term life and whole life insurance end. Now let’s dig into both kinds of policies individually and see how they differ.
Whole Life Insurance
As its name suggests, whole life insurance is considered a lifelong investment. You pay premiums for as long as your child will need financial assistance should you pass away and you may pay them even beyond that date. That’s because whole life insurance is a sound and very safe investment.
As you pay your premiums over the years, a whole life policy accumulates cash value. Your insurer may invest that cash in conservative assets that provide a modest return. You can borrow against the savings you amass in your policy before you die—for example, if you need the funds to send your kids to college. Other parents decide to withdraw their cash and cancel their policies when their kids reach the age when they can stand on their own two feet. What you do with the cash is up to you. Invest in a second home? Buy that luxury sports car you’ve always dreamed of driving? It’s up to you. The cash value of your policy is yours to use until your policy pays a death benefit. If you hold on to your policy until you die, the cash value of your policy disappears and your beneficiaries only receive the policy’s death benefit. That’s how whole life insurance works.
Term Life Insurance
Again, as its name suggests, you buy term life insurance for a set amount of time. That term may be anywhere from 10 to 30 years. Term life insurance is considerably less expensive than whole life. Long-term policies will have higher premiums because, as you age, insurers consider you a riskier policyholder. But no matter how long your term, your premiums will remain the same for as long as you keep your policy.
The key difference between term and whole life insurance is that term life only pays a death benefit. It doesn’t accumulate cash value. To put it plainly, term life insurance only has value if you die while you are paying premiums on it and before its term expires.
Choosing the Right Kind of Policy
If whole life builds cash value and is considered a safe investment, why do some parents choose term life? When you’re young and healthy, term life insurance is much more affordable than whole. Your term life costs may be 5 to 15 times less than a whole life policy that pays the same death benefit. Term life is temporary protection. Most parents buy it when they need it—before their kids are financially independent. They let it lapse when they can be sure of their kids’ financial security.
How Much Life Insurance Do You Need?
That depends on your family structure, your finances, and the kind of life you envision for your kids. Deciding how much life insurance you need requires you to imagine a future without you in your kids’ lives.
Are you a single parent? Do one of both of your kids’ parents work? If you’re a single parent or both parents in your family work, your kids won’t have your salary to depend on when you die. If only one parent is working, you can expect your family’s earnings to remain steady after your death.
What sort of life experiences do you want your kids to have? You may want the proceeds of your policy to fund one or more college educations. You may want your kids to attend summer camp or have music lessons. You may want to factor in pet-owning expenses, like pet insurance. Or perhaps even the cost of buying your kids a car when they graduate. Be sure to take the cost of child care into account, if that’s part of your monthly budget. In other words, the coverage limits of your policy should reflect the lifestyle you want your children to lead.
How Much Does Life Insurance Cost?
The cost of your policy will be primarily determined by three factors: the death benefit you choose, your age when you take out your policy, and your health. Buying a life insurance policy when you’re young and healthy can lower your premiums. Here’s one important tip: don’t smoke! Smokers may pay as much as four times for a policy as non-smokers.
If you purchase a million-dollar 20-year term life policy when you’re 30 years old and in the best of health, your policy premiums may be as low as $25 per month. Many insurance companies provide free quotes online and you should take the time to compare multiple policies. Does a million dollar policy sound excessive? Not when you consider that the cost of a college education can be $250,000 or more and that the annual cost of daycare averages nearly $10,000 per year. And not when you consider the priceless peace of mind you’ll have when you can rest assured that your children will be financially secure and enjoy the life experiences you want them to have, even if you’re not around to care for them.
Susan Doktor is a journalist, business strategist, and mother of twin sons. She covers a wide range of personal finance topics in her work, including insurance, homeownership, and investment strategies. Her contribution comes to us courtesy of Money.com.