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On the face of it, life insurance and retirement planning have little in common. In basic terms, life insurance is about dying “early”; retirement savings, dying “late.”

And retirement planning is for everyone, regardless of circumstances. Life insurance is part of a solid financial plan for those with families or others who depend on them for income, or for those who simply want to leave something to their heirs.

But a closer look reveals a deeper relationship.

Life Insurance and Retirement

A life insurance application on the screen of a lap top.

Along with providing income for one’s survivors, life insurance plays another, critical role: It allows people to be better retirement savers.

That’s because with a life insurance in policy in place, your need to hold a pile of cash reserves to cover an unexpected death and the resultant loss of income is greatly reduced. In exchange for relatively small monthly premiums, you’re getting access to cash that would otherwise take many years to save. If you need the money, you’ll have it. If you don’t, you’ll at least have enjoyed peace of mind.

At the same time, you’ll be able to focus on—and save more for—retirement. You’ll also have greater ability to choose long-term investments and be less susceptible to having to sell at an inopportune time, due to dire financial circumstances.

So it’s no surprise that RothIRA.com is a big advocate of possessing adequate life insurance. As such, we’re happy to be part of the Life Insurance Movement, an initiative started by our friends at goodfinancialcents.com.

How Much Insurance Do You Need?

Of course, this also begs the question: “Adequate life insurance”—what does that mean? How do you calculate the amount of insurance needed?

One common rule is to multiply your annual income by 10. But there’s no one magic number, of course. To arrive at the ideal sum for your situation, here’s a checklist of factors to consider.

  • What is the quality of life you would like for your family? You will need to plan on how an insurance payment will be invested, what rate of return can be expected, and the annual income it will provide.
  • Would your spouse be able to earn income? It is easy to imagine that a spouse can continue to provide for the family after your demise. In fact, it may be necessary for your spouse to leave a full-time job to take care of the children and the household.
  • Do you have other types of household income beyond your paycheck? This can include investments, child support or a second job.
  • Will you need the insurance policy proceeds to cover children’s education expenses? A college savings account is a beast that must be fed regularly if it’s to accrue enough to pay for tuition.
  • Do you wish to pay off or refinance your mortgage with the proceeds of a life insurance policy?  Mortgage payments are often a family’s single biggest monthly expense, and arguably the most important when it comes to quality of life.
  • Are there any other debts? These can include student loans, credit card payments or car loans.
  • Do any other members of your family, such as parents, count on your financial support? 
  • Will you owe estate taxes to the IRS? It is no use to properly plan for your insurance without taking into consideration your survivors’ tax burden.
  • Will there be any immediate major expenses upon your death, like funeral bills or medical bills, that aren’t currently covered?
  • If you are divorced, does your divorce agreement require you to maintain a certain level of life insurance?
  • Have you retirement savings that can be used to meet your survivors’ needs? Funds from retirement accounts often can be accessed in without penalty in cases of death; the advisability of doing so is another consideration.

Is Term Life Better Than Whole Life Insurance?

OK, you’re sold. You’re going to start shopping for life insurance. Now comes phase two of the project: deciding which sort of coverage to purchase. Life insurance policies come in two basic types: whole life and term life. We consider term life policies superior for several reasons.

The Advantages of Term Life Insurance

With a term life insurance policy, the insured purchases coverage for a set number of years. During that time, the premiums are fixed. This is a great option for parents who want to provide for their surviving spouse and children in the case of their deaths. By covering themselves during their productive years, they can be sure that their survivors will continue to enjoy the same standard of living, even in the absence of their income. Once they have retired, or there is no need to support survivors, there is no practical need to carry insurance.

The Drawbacks of Whole Life Insurance

A whole life insurance policy provides coverage for a specific term (or even for the whole life of the insured), but it also acts as an investment vehicle. The premiums you pay are partially put towards what’s called “cash value”—that is, they’re invested to grow with the market—so that, when the insured dies, the payout is greater than the original death benefit (that is, the policy’s face value) you purchased.

The problem is that whole life insurance costs more than term life since you are “buying” not just insurance coverage, but also making an additional investment. Unfortunately, the overall rate of return isn’t the strongest, especially compared to most retirement savings plans: The insurance companies charge very high commissions and fees while offering low, if stable, rates of growth. There are also up-front commissions that often equal the entire first year’s premium.

Finally, there is the uncertainty of using an investment vehicle as an insurance policy. Customers are never sure of the rate of return they will receive and being certain of a benefit is what life insurance policies should be all about. By comparison, those who are in good health and under 50 years of age will receive very favorable rates for term life insurance policies.

When Whole Life Insurance Makes Sense

Understandably, the costs for both types of policies rise with the age of the insured. As people get older, they may not even have the option to purchase term life insurance at a reasonable rate. At that point, in their late 40s or beyond, it may be worthwhile to look into a whole life insurance policy. Even with all the costs and fees, it might offer a better deal.

Whole life also offers some other advantages. Because you can borrow money against the accumulated cash value of the policy, a whole life insurance policy can benefit the insured even while they are alive. Some wealthy people may also wish to use the investment vehicle to provide tax savings to their survivors. Beneficiaries do not pay income tax on life insurance payouts and, if the insurance policy is placed in an irrevocable trust, it is also not subject to estate taxes.

Re-think Your Life Insurance and Retirement Periodically

Evaluating your life insurance needs is an admittedly grim task. And, though arriving at some numbers and purchasing a policy will take a great weight off your shoulders, don’t assume the job is finished forever. Experts recommend you re-assess your insurance needs each year, as life circumstances and the cost of living will inevitably change. Remember, too, that life insurance and retirement planning should go hand in hand.