When should you have life insurance...When should you cancel it?

Practical Rules of Thumb for Families and Business Owners

One of the most common financial decisions people make early in life (and then forget about for decades) is to purchase a life insurance policy. I often see clients who purchased policies when their kids were young and never revisited the decision. Sometimes those policies still serve an important purpose. Other times, it’s a waste of money.

Life insurance can be a very powerful financial tool when used thoughtfully. It can protect young families, provide liquidity to support a business transition, or help address estate tax concerns. At the same time, insurance is sometimes sold in situations where it may not be necessary or may be more expensive and complicated than it needs to be.

I am not an insurance agent (and don’t want to be!) but life insurance frequently comes up in estate planning conversations with clients. Here are some practical guidelines I often share with clients when discussing the topic. 

When Children Are Young, Life Insurance Often Makes the Most Sense

For many families, the clearest reason to own life insurance is to protect children while they are financially dependent. If one parent dies unexpectedly, the surviving parent may suddenly lose a major source of income. Life insurance can help replace that income and ensure that the surviving parent can continue to pay for housing, childcare, education, and other family expenses.

This is one of the most common situations where term life insurance makes sense. Term insurance provides coverage for a specific period (typically 20 or 30 years) and is generally much less expensive than whole life policies (the difference is discussed below).

As Children Become Independent, the Need Often Declines

As children grow up and households accumulate retirement savings and other assets, the need for life insurance often declines. If a surviving spouse already has sufficient assets to support themselves, continuing to pay premiums for large policies may no longer make sense. The money spent on premiums could be invested differently.

At that point many families choose to reduce coverage or eliminate it entirely.

This leads to an important concept: self-insurance.

The “Self-Insurance” Moment

A useful way to think about life insurance is that it protects against financial risks that your family cannot yet absorb on its own.

Early in life, many families rely heavily on income from employment. If that income disappears, the financial consequences could be severe.

Over time, however, savings, retirement accounts, and investments may grow large enough that a surviving spouse or family could maintain their lifestyle without insurance proceeds. At that point, the household may effectively be self-insured, and continuing to carry large life insurance policies may no longer be necessary.

The “10× Income” Rule (And Why It’s Often Too Simple)

You may have heard the rule of thumb that people should carry life insurance equal to ten times their income.

While that rule can provide a rough starting point, it is often too simplistic. The right amount of insurance depends on many factors, including:

• The age of your children

• Whether a surviving spouse works

• Your mortgage and other debts

• Education funding goals

• Existing savings and retirement accounts

In other words, the appropriate amount of life insurance should be tied to the actual financial needs of your family, not just a simple multiple of income. Financial advisors are perfect for helping you think through the math. 

Term Insurance vs. Whole Life

Another common question is whether to purchase term insurance or permanent insurance such as whole life or universal life. Term insurance is generally straightforward and affordable. It provides protection during the years when families are most financially vulnerable. Permanent insurance combines insurance with an investment or savings component. These policies can sometimes be useful in specialized planning situations, but they are often more complex and can be significantly more expensive.

For many families, term insurance is sufficient for the years when protection is most important.

Life Insurance and Family Businesses

Life insurance can play an especially important role when a family owns a closely held business or farm.

When a business owner dies unexpectedly, the family may suddenly face difficult decisions. Will the company need to be sold? Will there be enough liquidity to buy out partners or equalize inheritances among children?

Life insurance can provide liquidity that allows a business to continue operating and remain in the family.

The Business Owner Liquidity Test

Business owners sometimes overlook a simple question: If the owner died tomorrow, would the family have enough liquidity to keep the business without selling it?

If the answer is no, life insurance may provide a solution. A properly structured policy can create the funds necessary to stabilize the company during a transition period or support a buy-sell arrangement among owners.

Life Insurance and Estate Planning

Life insurance proceeds typically pass outside of probate when there is a designated beneficiary. However, they are usuallly still included in the taxable estate if the insured person owned the policy at death.

For families concerned about potential estate taxes, an Irrevocable Life Insurance Trust (ILIT) can sometimes be used to keep insurance proceeds outside of the taxable estate. These trusts can also be used to ensure liquidity for heirs, fund inheritances, or support long-term planning for future generations.

Be Cautious with “No Medical Exam” Policies

Later in life, many people encounter advertisements for life insurance policies that promise coverage without a medical exam. These policies are often marketed as a simple way to cover funeral expenses or final costs. While these products may serve a limited purpose, they often come with significant restrictions. Premiums can be relatively high for the amount of coverage provided, and many policies contain waiting periods during which full benefits are not available. For that reason, these policies should be evaluated carefully before purchasing.

Five Signs You May No Longer Need Your Life Insurance Policy

Here are a few signs that it may be time to reconsider your coverage:

1. Your children are financially independent. If your children are grown and supporting themselves, the original purpose of your policy may no longer exist.

2. Your surviving spouse would already be financially secure. If your spouse could maintain their lifestyle using retirement accounts, savings, and other investments, insurance may no longer be necessary.

3. Major debts have been paid off. If your mortgage and other obligations are gone, the financial risk to your family may be significantly lower.

4. Your investment assets have grown substantially. At some point, accumulated assets may provide enough financial security that life insurance becomes redundant.

5. The premiums no longer make sense relative to the benefit. Some policies become expensive later in life. In those cases it may be worth reviewing whether the premiums are still justified.

Life insurance decisions should evolve over time, just like the rest of your financial and estate planning.

The Bottom Line

Life insurance can be a powerful financial tool when used thoughtfully, but it is not something every family needs forever. The right time to own life insurance (and the right time to drop it) often depends on life stage, family responsibilities, and overall financial resources.

Like many aspects of estate planning, it works best when reviewed periodically as life circumstances change.