Life Insurance: Security for your Family's Financial Plan
Most people don’t even like to think about it, much less talk about it. Life insurance, however, is a key part of your financial plan. Yet, despite its importance, life insurance is not well understood by most people. How much coverage do you need? For how long? What kind of coverage is best? The insurance industry doesn’t offer much help, with legions of sales folk knocking on doors trying to sell complex insurance product which seem designed to confuse and perplex rather than simplify and enlighten. (apologies to my agency friends!)
The need is urgent and real! When I was younger, I understood the need for insurance on a theoretical basis, but the concept of premature death seemed somewhat remote. In fact, I was significantly underinsured myself when I was in my thirties. But as I passed through my 40’s and entered my 50’s (yikes that still hurts), I have seen people around me, in my personal life and through my financial planning practice, deal with cancer, heart attacks, rare diseases – you name it. My own younger brother died of cancer at the age of 38, driving the hard reality of my own mortality. I have also seen just how dependent a surviving family can be on life insurance, and how difficult life can be for surviving dependents of the uninsured. It then perplexes me when in my practice I see many people who seem to have given the subject very little thought!
Who needs it? This is simple! If anyone you care about relies on a source of income that depends on your continued presence on this planet, then you need life insurance. The obvious example is the family breadwinner supporting a lower earning spouse and dependent children. If you are in this situation and you die, your family may be almost entirely dependent on insurance. There may be other less obvious examples as well. Did you take a life only pension option upon retirement? What will happen if you die first? Do you have debt, obligations, or goals (such as education) which would require two incomes? Insurers frequently make the case for insurance on a non-working spouse based on the idea that the surviving spouse would incur financial hardship in the form of additional household help, child care, etc.
How much do you need? Forget all the simplistic rules of thumb such as 10 times your income, etc. They don’t work. Following such rules will leave some people underinsured and others wasting money on insurance they do not need. The only way to make sure you have adequate insurance is to take stock of your own situation and ask this question: If I were to die, how much of my income would I need to replace, and for how long, in order for my loved ones to be able to live the life I wish for them to live? That part might not be too hard – but you typically don’t buy insurance in terms of replacement income, you purchase a single lump sum death benefit. Financial types use a concept called Present Value to attach a value today to a future stream of desired income. A discussion of present value calculations is a bit beyond the scope of this post, but any competent insurance professional or financial planner can run the numbers for you if you have a good handle on the income replacement you think you need.
I have group insurance from work, is this enough? Well, this goes back to the question above. If you need a large sum of insurance to support a dependent spouse and children, your employer insurance is probably insufficient. There are two other things to consider regarding group life insurance. First is that your coverage will most likely lapse if you leave employment, maybe even just when you need it most. Some group policies allow for continuation, but only as expensive permanent policies. You may find you leave your employer with some medical condition that renders you uninsurable. Relying entirely on employer insurance is not a good idea. Furthermore, if you are in good health, employer group insurance may be quite expensive. You may find you can buy much more insurance, for less money, in the private market. The reason is that group insurers need to provide a single rate for everyone in the group, regardless of age or health. That is good if you are old or sick, but if you are young and healthy you may not be getting the best deal. In that case, take what the employer provides for no charge (usually 1X salary) then go buy your own insurance in the open market.
What kind of life insurance do you need? Most people will receive the best value from term life insurance. It permits you to buy a large death benefit for a reasonable fixed price - but only for a limited period of time. This is ideal for families, whose insurance needs will change over time. As the family grows, the demands on the family’s breadwinner(s) reach a peak. Once the children become independent and the mortgage is paid down, the need begins to decrease. As the couple retires and begins to live off pensions (with survivor benefits) and savings, the need for life insurance may dwindle away to nothing. Term insurance is ideal for this traditional lifestyle approach to financial planning, as the product can be purchased to match the changing need. Permanent insurance (whole life, universal life, etc.) offers the promise that your coverage will never run out, but it is so expensive that most individuals cannot afford sufficient coverage to provide the level of protection their families need when they really need it! Make no doubt about it, most insurance agents WILL try to convince you that you need something more expensive than term, and permanent insurance does have its place in certain applications. But when facing the sales pitch it is important to keep in mind that commissions on permanent insurance products are much higher than term, and agents are trained to “up sell” to increase revenues.
What about “cash value”? Term life policies have no investment value. If you stop paying the premiums, the policy terminates. Permanent policies (whole life, universal life, etc.) usually offer an investment component, which increases in value over time. If you hold these policies long enough for the cash value to accumulate (and that is a big IF), you can borrow against the investment value, or you can “surrender” the policy – in effect terminating the policy and taking out the accumulated cash value. In my experience, the investment feature in most insurance policies is overrated. The associated costs and charges are too much of a drag on investment growth. Buy life insurance for the death benefit your family needs for its security. Buy investment products to grow assets. In my opinion, mixing the two together serves little purpose and results in unneeded complexity and cost. Others may have a different opinion.
Can I save money buying life insurance on the internet? Not based on my experience. Websites that advertise “shopping for the best rate” use the same tools that an independent insurance agent would use to shop for the same term policies from the same companies. Insurance rates are negotiated and approved at the state level, so the price from a given insurance company for a given product can’t really be “discounted”. Rates do differ, and sometimes dramatically, from company to company however, so you will almost always find a better deal from an independent agent who can shop across the market than from an agent who is employed by an individual company.
It is all part of a “bigger picture”. As a Certified Financial Planner™ I am biased in favor of the idea that most financial decisions are best considered as part of a bigger overall financial plan. This is no different for life insurance. Putting all your goals down on paper and mapping out the steps you need to take to achieve those goals is going to make more effective use of your resources than considering each component as an independent transaction. For those who want to learn more about financial planning, the CFP Board of Standards provides a financial planning toolset at www.letsmakeaplan.org , and also lets you connect with a Certified Financial Planner if you need additional help.