As a financial planner, I recommend life insurance to people in 5 situations (2024)

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• As a financial planner, I've seen many people who have too much life insurance coverage for their needs or a policy that doesn't make sense for their situation.
• I typically recommend life insurance if someone depends on you financially, your heirs will have to pay estate tax, or you own a business.
• It also makes sense if you need an alternative to long-term care insurance, or you've exhausted your tax-deferred savings options.

Life insurance is one of the oldest financial instruments in our country. It's a product that's been around for centuries and, throughout the years, it's gone through countless iterations and enhancements.

These changes are often good for consumers, but they have also opened the door to overselling and misusing life insurance. Unfortunately, I often see people who have too much coverage for their needs or who bought a policy that doesn't make sense for their specific situation.

To help you navigate when life insurance makes sense, let's walk through five scenarios that could make you a good candidate for life insurance.

The number-one reason why someone needs life insurance is simply to replace income.

If you have a minor child, a spouse, or an adult child with special needs depending on your income, then life insurance is a great way to protect them from financial hardship should something unexpected happen to you.

In this case, you might want to consider getting enough life insurance coverage so that the death benefit would provide enough funding for your loved ones to afford the same lifestyle they have now for however long you wish them to do so.

As it stands today, the highest tax rate is in the form of the estate tax. The current federal estate tax rate is 40% of your taxable estate at the time of your death.

In addition to this federal tax, you may also need to consider state estate or inheritance taxes. Depending on your state of residence, one or both of these could also apply. That would slap your estate with an additional tax, as high as 20%.

Life insurance won't let you avoid or minimize what you owe, but it does provide your heirs with immediate liquidity (taxes are due nine months after death) and a cost-effective way to pay your estate tax bill. But make sure the policy is not owned by you; the death benefit amount of the policy, if it's not owned by a trust, will just be added to the value of your estate and only increase taxes owed.

In the United States, 99% of all businesses are considered small businesses. If you are fortunate enough to own or work at a successful one, life insurance might be an essential tool to protect the viability of your company even after your death.

The death benefit or cash value from a policy can be used to retain key employees, create a discriminatory retirement plan benefiting highly compensated employees, and to provide liquidity for owners to buy each other out, respectively, in the event of death or retirement.

Using life insurance as a tool for business succession and/or retirement has a lot of advantages. Insurance premiums are often a tax deduction to the employer, and if your business is doing really well, employers are able to implement these strategies on top of other tax-favored vehicles like company retirement plans.

If you were recently denied long-term care insurance or are afraid to apply due to health concerns, then a hybrid life insurance policy with long-term care provisions might be the answer to your problem.

Annual premiums are locked in, medical underwriting can be less rigid than traditional long-term care insurance, and some policies still offer a cash indemnity option.

Just beware that although a hybrid option is built to serve two purposes, it is best practice for you to use it for either life insurance coverage or long-term care protection. Using it for the latter means it should address those expenses and the death benefit is just a bonus.

Hybrid policies can not handle both needs, as long-term care benefits are paid out, they reduce your cash value and/or death benefit within your life insurance policy.

If a life insurance policy is properly built to accumulate cash, it can be used as a tax-favored vehicle for savings. Using life insurance as an investment can provide benefits such as tax-deferred growth within your cash value, ability to withdraw cash value tax-free via policy loans, and avoiding annual contribution limits like you have with 401(k)s and IRAs.

But be warned: This should only be considered once you've exhausted (or maxed out contributions to) all other tax-favored investment vehicles. The internal cost of insurance policies can be high thanks to administration fees and mortality and expense risk charges, and some people may be better suited directing money they would have paid on premiums to something like a low-cost, diversified portfolio in a brokerage account.

If you are not careful, you can end up paying a lot of unnecessary costs, which will severely lower your overall rate of return.

The bottom line is that life insurance can be a useful way to leverage a financial strategy to grow and protect your assets. But know there are many types of insurance products available, and not all will be aligned with your needs and goals. Consider speaking with a financial planner who is a fiduciary to get an objective opinion about whether or not a particular policy makes sense for you.

Malik S. Lee, CFP, CAP, APMA, is a financial expert with nearly two decades of experience and is the founder of Felton & Peel Wealth Management.