When you are in your 20s or even your 30s, paying for life insurance may seem like an unnecessary expense. And for many people, it’s not needed. There comes a time, though, when life insurance can be important.

To decide whether you need life insurance, the essential question to ask is whether someone would be financially worse off if you are gone.

After all, the purpose of life insurance is to replace your income or assets for people who depend on it.

Singles who don’t have children or parents who are dependent on them and who don’t have debt may not need life insurance. No one depends on their income, and expenses are likely to be low.

Even though insurance agents may say that insurance is cheaper when you are young and healthy, so it is a good idea to get a policy early, you may end up paying for insurance you don’t need.

That said, there are a few exceptions.

If you’re starting a small business, for example, term life insurance might make sense so that the company has money to survive if you are gone.

Or if you have large loans from your education, life insurance could be used to pay them off.

If you get married or buy a home or start having children, however, your situation changes dramatically.

You would want your children to be able to get a good education and your spouse to have enough money to take care of your family if you’re not around. It’s better to get enough life insurance to replace your income so that your spouse can carry on with paying the mortgage and other expenses.

HOW MUCH IS ENOUGH?

If you decide you do need life insurance, the first step is to figure out how much to get.

Very simply, the payment from the insurance policy should be enough for your dependents to live on. That doesn’t mean you need to replace your entire income, though, since expenses will be less if there is one fewer person in the household.

To calculate how much you need, insurance firm Singapore Life suggests calculating the gap between your long-term financial obligations and your assets.

First, calculate your dependents’ needs for living expenses until the children go to or finish their studies at the university, the children’s education expenses and your debts.

Next, add up the assets in your investment portfolio and savings, and any payments your family may receive from your employer or another insurance policy.

The gap between needs and assets gives an indication of how much life insurance you should consider getting.

An alternative is to use a tool such as the life insurance needs calculator by the American Institute of CPAs. Although it’s built for Americans, it can take you through expenses you need to consider and come up with an indicator of your life insurance needs. 

TYPES OF INSURANCE POLICIES

Next, you will need to figure out the type of policy to buy.

While life insurance might seem like an easy concept, it can really be complicated.

Types of life insurance include term, whole life, endowment and investment-linked policies.

National financial education programme MoneySense says that term and whole life insurance provide your dependents with financial support in the event of your death, while endowment or investment-linked policies provide for your savings and investment.

If you simply need protection for your dependents, term life insurance can be a better option. Term insurance provides protection for a fixed period, such as 20 or 30 years, and then expires. The coverage is cheaper and can cover the entire period when your dependents need your support, such as up until your children finish their university studies. Some advisers suggest that term life is sufficient for most families.

Whole life insurance, on the other hand, covers you as long as you continue to pay the premiums. 

While endowment plans and investment-linked policies (ILPs) have an insurance component, they are somewhat different.

Endowment policies have a savings component that may offer a target return or even a guaranteed value.

ILPs replace savings with investments that can rise or fall. The value of the ILP thus depends on the performance of the fund you bought, and you could end up with a lot if the fund does well or very little if it performs poorly.

While it’s much more expensive, it may grow your money and you may  be able to access some of your accumulated funds for expenses such as your children’s education..

It is also important to understand that life policies include three parts — the cost of insurance, the cash value and administrative costs — as Nasdaq writer Matthew Blume explains it.

Even though term policies also include administrative costs, the levels are lower than for endowment or investment-linked insurance. By a large margin, Blume calculated, an investor who wants both life insurance coverage and to maximise the value of his or her assets would be better off buying a cheaper term insurance and putting the extra money into an investment account instead.

Rather than just buying life insurance because an agent recommends it or friends are buying it, consider whether you really need a life insurance policy. If you do, carefully select the right one that meets your needs best.