Why Is It Important to Have Life Insurance?

Life insurance is a contract where an insurer pays a death benefit to designated beneficiaries upon the insured person’s passing. This financial arrangement serves as a foundational element in comprehensive financial planning, providing monetary protection to loved ones and helping to secure their future in the face of unforeseen circumstances.

Providing Financial Security for Loved Ones

Life insurance offers a financial safety net for family members who depend on the policyholder’s income. The death benefit can serve as income replacement, helping to cover ongoing household expenditures. This includes regular bills such as mortgage payments, utility costs, groceries, and transportation.

The payout enables surviving family members to maintain their accustomed standard of living. Financial professionals suggest calculating income replacement by considering a multiple of the annual salary for a specified number of years, 8 to 10 times the salary, to ensure adequate coverage. This ensures daily expenses continue to be met, providing stability during a difficult period. The funds can bridge the financial gap, allowing families to grieve without the added stress of economic instability.

Managing End-of-Life Costs

Upon a person’s passing, several immediate and substantial costs arise, which life insurance can help manage. Funeral and burial expenses represent a significant financial obligation. The median cost for a funeral with viewing and burial in the United States ranges from $8,300 to $9,995, while a cremation funeral with a viewing averages around $6,280. Direct cremation, a more economical option, can cost approximately $2,202.

Beyond funeral arrangements, outstanding medical bills can also present a burden. A deceased person’s medical debt is paid from their estate before any assets are distributed to heirs. Family members are not responsible for these debts unless they co-signed for medical treatment or reside in a community property state. If the estate lacks sufficient funds to cover the medical debt, creditors write off the remaining balance, meaning it does not transfer to heirs.

Estate administration costs, legal and administrative fees, also need to be considered. These expenses can range from 2% to 8% of the estate’s total value. This percentage covers attorney fees, 2% to 5% of the estate, and executor fees, ranging from 1% to 5%. Life insurance can provide immediate liquidity to cover these end-of-life expenses, preventing surviving family members from having to liquidate assets or incur additional debt during a time of grief.

Securing Future Financial Milestones

Life insurance also secures long-term financial objectives for surviving family members. The death benefit can fund a child’s college education. Permanent life insurance policies can accumulate cash value over time, which policyholders can access through loans or withdrawals to cover tuition costs. These policy loans are income tax-free and do not count against a student’s eligibility for financial aid, providing a valuable resource for higher education funding.

The policy payout can be directed towards paying off significant debts, such as a mortgage, car loans, or personal loans. This allows beneficiaries to eliminate financial burdens, ensuring they retain assets. While specialized mortgage life insurance exists, a general life insurance policy provides funds that beneficiaries can use to pay off the mortgage or other debts, offering flexibility in how the funds are utilized. The death benefit from life insurance is not subject to federal income tax for beneficiaries when received as a lump sum, ensuring the full amount is available for these financial goals.