The two principal characteristics of term insurance are: the insured must die for any benefits to be paid and, by definition, the contract expires at the end of the term. Stated more specifically, a term life insurance policy promises to pay a death benefit to a beneficiary only if the insured dies during a specified term.

The contract makes no promise to pay anything if the insured lives beyond the specified term. Generally, no cash values are payable under a term life insurance contract. If the insured survives the specified term, the contract expires and provides no payment of any kind to the policyowner.

1) When should term life be purchased?

In general, some type of life insurance is indicated when a person needs or wants to provide an immediate estate upon his or her death. This need or desire typically stems from one or more of the following reasons:

A. Providing income for dependent family members until they become self-supporting after the head of household dies.

B. Liquidating consumer or business debts, or to create a fund, enabling the surviving family members to do the same when the head of household dies.

C. Providing large amounts of cash at death for children’s college expenses or other capital needs.

D. Providing cash for federal estate and state inheritance taxes, funeral expenses, and administration costs.

E. Providing funds for the continuation of a business through a buy-sell agreement.

F. Indemnifying a business for the loss of a key employee.

G. Helping recruit, retain, or retire one or more key employees through a salary continuation plan, and finance the company’s obligations to the dependents of a deceased key employee under that plan.

H. Funding bequests of capital to children, grandchildren, or others without the erosion often caused by probate costs, inheritance taxes, income taxes, federal estate taxes, transfer fees, or the generation-skipping tax.

I. Funding charitable bequests.

J. Preserving confidentiality of financial affairs. Life insurance proceeds payable to someone other than the deceased’s estate are not part of the probate estate and are not a matter of public record. It is not unusual for a beneficiary to be a lover, illegitimate child, faithful domestic servant, or have some other type of relationship with the insured that he or she may not want to be publicly acknowledged.

K. Assuring nearly instant access to cash for surviving dependents. Life insurance proceeds are generally paid to beneficiaries within days of the claim. There is no delay, as might be the case with other types of assets, because of the intervention of state or other governmental bodies due to settlement of tax issues, or because of claims by the decedent’s creditors.

L. Directing family assets to family members in a way that minimizes state, local, and federal taxes.

Generally, term insurance is not the most effective type of life insurance for all of these death benefit needs. However, term insurance may serve the insured’s needs in many circumstances. Because term insurance is not just one product, but rather many variations on a general theme different types of term insurance are indicated for different types of needs.

Keep in mind, term insurance, more than any other type of insurance, is pure death protection with little or no ancillary or lifetime benefits. Therefore, the two overriding considerations in the use of term insurance, regardless of the specific application, are:

• Will death protection alone meet the need?
• Will the coverage last as long as the need?

In short, with term — as with any other decision about the appropriate type of coverage — the product must match the problem.

Figuring out your life insurance needs sounds trickier than it actually is. The important thing is first determine whether you need life insurance, which kind is best for you and carefully calculate how much you need.

All we have to do is be clear about what your situation is, what risk to mitigate and voila, you have your answer.

First question: Do you need life insurance at all?  If you have dependents to protect and don’t have enough savings, you definitely need insurance.

Second question: Which kind of insurance should you get? If you want to protect your family against the destruction of your business or estate taxes after your death, whole life or universal life insurance has to be considered.  But if your main concern is to protect your family against a loss of your income, term insurance is the way to go.

Finally, how much insurance do you need? This question is also pretty straightforward. It takes a few steps, but it’s not rocket science. Let’s go through it:

1. How much debt do you have other than your mortgage? If you have any other debt, you are spending more than you earn. Do you add to your debt each month? Do you pay it down each month? If you have debt, you have to buy more life insurance to pay it off.

2. How much do you spend each month? The most accurate way to determine your monthly needs is to use a personal budget software package, but you can also use your bank statements to estimate your spending.

You can’t protect your family if you don’t know how much you need every month. Don’t just guess. You might think that $500,000 in term coverage is sufficient. After all, it’s a lot of money. But give it careful thought.  You may find that this is not enough.

If you die and your family gets the $500,000, what can they do with it? They might invest it using an income diversity strategy and maybe earn 5%. That amounts to just $25,000, of yearly investment income. So, if you earn $25,000 in salary, a $500,000 term policy is plenty. But if your family depends on more than $25,000 each year, you need more coverage.

3. How much do you save each month? If you put away money every month and live within your means, keep it up. In fact, you probably don’t need to replace all of your income, so you need less term life insurance.

4. What are your longer-term saving goals? How much money do you need to retire and pay for your immediate future? Are you saving enough to fund your future automobile purchase, retirement and education for the kids?

If you have funds set up for nonrecurring but expected outlays, fine. Otherwise, you need more coverage.

5. How much income do your survivors need if you aren’t around? This is the only thing that really matters when it comes to determining how much life insurance you need. But to answer this you have to first add up your answers for the above questions.

Let’s say you know you spend $6,000 each month to pay all your bills including taxes. You calculate this using a personal budgeting software program so you know you are on target.

Let’s also assume that this $6,000 pays for everything including future college education, automobile purchases and retirement. Of the $6,000, you earn $3,500 and your husband earns $2,500.

You run a financial plan and figure that by age 65, your maximum social security benefit and income from your investments will replace your earned income. That’s when you retire. (Without a financial plan it’s really tough to know how much insurance you need.)

After you do this exercise, you know that you need to replace your income until you reach 65. That’s $3,500 per month for you and $2,500 for your husband.

Your monthly income is equivalent to $42,000 a year. You need enough term insurance so that if you pass away, you could invest the proceeds and earn $42,000 after tax. How do you calculate that?