Do I Need Life Insurance?

People typically buy life insurance when they get married, or have or adopt a child. Suddenly there's a new person in their life who relies on their income to live. What if one spouse or parent passes away unexpectedly? How will the family continue to pay the rent or mortgage, or pay for the child's school or day care? That's where life insurance comes in.

In its most basic form, life insurance replaces lost income if the insured person dies. The financial planning guru Dave Ramsey recommends buying a life insurance policy equivalent to 10 to 12 times your annual income. So, if you make $40,000 a year, you should buy a policy that pays out $400,000 or $500,000 in the event of your death.

Why 10 to 12 times your income? Ramsey's logic is that the surviving spouse or dependents can invest the $400,000 or $500,000 and live off the interest. If you put that money in a mutual fund or another slow-and-stable investment, you can expect to earn 8 to 10 percent interest every year. Ten percent of $400,000 is $40,000, so the surviving family members can replace the lost annual income without touching the original life insurance payout.

If both spouses work, then both will need their own life insurance policy. That way, if either person passes away, the surviving spouse won't have to sacrifice their quality of life in order to pay the bills.

But what about stay-at-home parents? Do they still need a life insurance policy? Most financial planning experts say yes. The primary reason for life insurance is to replace lost income, but it also can help cover new expenses incurred by the death of a loved one.

Think of all of the unpaid work that a stay-at-home parent provides: child care, education, shopping, meal preparation, house cleaning, laundry, coaching, the list goes on. The cost of child care alone could be tens of thousands of dollars a year depending on the location and how many children need care. For stay-at-home parents, Ramsey recommends buying a smaller life insurance policy — maybe $250,000 to $400,000 — with a shorter term that ends when the children are expected to be out of the home.

Even if you're single and don't have any children, there might be other people in your life who depend on you financially. Jack Dolan, vice president of public affairs at the American Council of Life Insurers (ACLI), says that while parents with children are the most common life insurance situation, "you can expand that list very quickly."

Perhaps you don't have any children of your own, but you regularly help a sibling or friend make their rent payments or pay for school. Maybe you don't plan on having children, but would like to contribute to your niece's or nephew's college savings fund. Dolan says that if you've made commitments to provide financial support to other people in your life, you can buy a policy and designate those individuals as the beneficiary.

Outside of family and friends, there may be other individuals or even institutions that rely on you financially. Business partners are a good example. If you co-own a small business, your untimely death would be a huge personal loss as well as a financial one. Consider taking out a policy that replaces the annual earnings that you directly provide to the business.

Do you give generously and regularly to any charities? Do you volunteer long hours at a local nonprofit organization? Are you a stalwart donor to your college or university alma mater? If so, then those institutions have come to rely on you financially. Dolan says that you could take out a small life insurance policy that names these organizations as the beneficiary so you can keep supporting them even if you're gone.

One other solid reason that a single person with no dependents should consider buying life insurance is the cost. As a general rule, health insurance companies give lower monthly premiums to people who are younger and healthier. So, if you're in your 20s or 30s and expect to get married someday and have children, it might be smart to lock in a low monthly rate now that will save you money later.

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