Life Insurance — Why and How Much?
“The only thing you take with you when you’re gone is what you leave behind.” John Allston
Why Have Life Insurance
Life insurance is a unique asset. Because of its potential high yield and its tax-favored benefits, it can be used to solve some of life's perplexing financial problems. Generally, when life insurance is mentioned, one thinks of providing for family members after the passing away of an income earner. However, there are many other uses, which I will enumerate below.
Create an estate: Where time or other circumstances have kept the estate owner from accumulating sufficient assets to care for his or her loved ones, life insurance can create an instant estate.
College fund for children or grandchildren: Cash value increases in a policy on a minor’s life (or the parent’s life) and can be used to accumulate funds for college.
Pay off a home mortgage: Many people would like to pass the family residence to their spouse or children free of any mortgage. Often a decreasing term policy is used, which decreases in face amount as the mortgage balance is paid down.
Replace a charitable gift: Gifts of appreciated assets to Charitable Remainder Trusts can provide income and estate tax benefits. Life insurance can be used to replace the value of the donated assets. Proceeds from life insurance policies can also be paid directly to a charity.
Equalize inheritances: When the family business passes to children who are active in it, life insurance can give an equal amount to the other children.
Pension maximization: At retirement, married pension plan participants must make a choice to either: (1) take the maximum monthly income for the life of the retiring employee or (2) take a substantially reduced monthly income for the lifetimes of both the retiring employee and his or her spouse.
The pension maximization strategy uses a permanent life insurance policy to provide a death benefit to the surviving spouse sufficient to replace the income that might have been received if the joint and survivor option had been chosen.
Types of Insurance Policies
Decreasing Term: Level premium, decreasing coverage, no cash value. This type of insurance is suitable for financial obligations which reduce with time. Obligations such as mortgages or other amortized loans.
Annual Renewable Term: Increasing premium, level coverage, no cash value. Suitable for financial obligations which remain constant for a short or intermediate period, such as income during a minor’s dependency.
Long-Term Level Premium Term: Level premium, level coverage, no cash value: The annual premiums are fixed for a period of time, typically 5,10, or 20 years. Suitable for financial obligations which remain constant for a short or intermediate period.
Whole Life: Level premiums, level coverage, cash values. Cash value typically increases based on the insurance company’s general asset account portfolio performance. This type of insurance is most suitable for long-term obligations, such as surviving spouse lifetime income needs, estate liquidity, death taxes, funding retirement needs, etc.
Universal Life: Level or adjustable premium and coverage, cash values. Cash values may increase based on the performance of certain assets held in the company’s general account. Suitable for long-term obligations. A variable of this type of insurance, is Variable Universal Life, in which the premiums are invested in the stock market and the growth in value is tied to the market return.
How Much Is Enough?
How much life insurance one needs is based on each person’s individual situation. The amount I need is probably far different from the amount anyone else needs. However, a good place to begin is to calculate the annual living expense of your surviving spouse and children.
Once you have a good handle on their living expenses, subtract any annual income they may receive. Items such as Social Security benefits, survivor’s pension benefits, and survivor’s earned income would fit into this category.
Subtracting the expected annual income from the annual living expenses then gives you the annual net living expenses shortage.
To this annual shortage, you should add lump-sum expenses such as final expenses and/or estate costs, mortgage cancellation expense, an emergency fund etc.
Now you can calculate the capital required to produce the income required to meet the annual living expenses and meet the lump-sum expense requirement.
Finally, there are numerous financial calculators on the web which may help you estimate the right amount of life insurance to meet your needs. One such calculator can be found at:
http://moneycentral.msn.com/investor/calcs/n_life/main.asp
Insurance for the Retired
Once you’re retired, many of your insurance needs change. You may be able to jettison some policies, but there are others you shouldn’t go without. Below is a listing of insurance particularly important to retired persons.
Health Insurance
Medicare coverage doesn’t kick in until you’re 65, so if you’re planning an early retirement, you’ll need to factor in the costs of paying for your own coverage for several years. Going without insurance is too big a risk to take since one illness or accident can wipe you out financially.
Liability Insurance
With more assets than ever, you could be at an even bigger risk of being sued. Make sure you keep the maximum available liability coverage on your homeowners and auto insurance.
Long-Term Care Insurance
This type of policy covers expenses that health insurance and Medicare typically do not: the costs of a nursing home or home care if you’re too disabled or ill to take care of the basic functions of daily living, like feeding, bathing or dressing, by yourself. The costs of such care typically start at $30,000 to $40,000 per year.
Homeowner’s Insurance
Even if your home is paid off, you most likely will still need the protection homeowners insurance can provide. Not only will it rebuild your house, but homeowners insurance also provides liability protection in case you get sued.
As a financial planner, I maintain relationships with other financial professionals in the areas of tax, estate planning and insurance. If you’d like to discuss your particular insurance needs and/or review your current policies, please just give me a call and I’ll arrange an appointment with a trusted independent agent.