Life Insurance
Yesterday's post on how to calculate how much life insurance is needed received some great comments. For those who don't typically read comments, I have copied and pasted them for you here:
The first response came from Jim at Accountability is King:
JLP,
A couple of things to consider:
It is usually cheaper to pay all of your debt off with life insurance leaving your family with no monthly debt payments. Remember, though, to adjust your annual income needs accordingly. If there is no mortgage anymore, don't insure yourself for that monthly expense. Reduce your monthly income needs accordingly. One way people commonly end up over-insured is that they forget the cost of living will go down substantially once all debt is paid off.
Also, I am an advocate of carrying the bare minimum in insurance. What I mean is to cover all bases just like you've said, but never round up or estimate. Get the numbers down cold and then do your calculations. Where you rounded to $1M, I would only buy exactly 978 units (a unit being $1,000). There are insurance companies that will sell exactly the number of units you need. Save as much as possible and invest the difference into a fund that moves you toward being self-insured.
Remember, you'll need to be self-insured by the time your term-life policy runs out. Have your advisor figure out how much that will need to be (including a downward adjustment since you'll be debt free by then if the advisor is doing their job right).
Over-insuring yourself seems like a good thing, even honorable. But it bears a substantial cost. Diverting that money elsewhere (debt elimination, or preferably saving to be self-insured) is a better route. In other words, focus on eliminating the burden you would place on your family. Eliminate your debt, create an emergency fund, etc., but do it now. Don't depend on insurance to do it for you. Only use insurance to the extent and for as long as absolutely necessary until the burden you leave has been essentially eliminated.
Once you've achieved certain milestones, reduce your insurance accordingly and again invest the difference. For example, once you've established an emergency fund, reduce your insurance by the amount needed to create one if you had died. Once you've paid off your mortgage, reduce your insurance by the amount you had needed to cover your mortgage if you died.
Your goal is financial independence. That goal is a line on a graph somewhere. Your current situation is another line somewhere below inependence. The only reason to hold insurance is to cover the gap between those two lines.
Over time, your "current" line will move up as your savings increase. Your "independence" line will move down as your debt is paid off. As the gap between the two lines becomes smaller, your insurance should become smaller as well.
Summary: Don't give insurance companies any more money than you absolutely have to. Invest the rest for the benefit of your heirs.
Jim Voigt Homepage 06.21.05 - 3:14 pm #
The second response came from Dan at Catablast:
What I tell my clients with kids is that they should take thier annual income and multiply it by the # of years until the youngest has left the house, typicaly age 21 (after college).
Clients with spouses but no kids should have their annual income multiplied by the number of years left before the spouse reaches age 65 (retirement).
Single individuals may or may not need life insurance, but it never hurts to take out a small perm policy to cover final expenses and burial costs. Single people with considerable debts -- like student loans -- would not be pleased to see their parents shouldering their bills after they're gone.
If I'm dealing with a single and wealthy individual, they may go for a policy which will provide liquidity for estate planning purposes. Shletered in an irrevocable trust, that policy will reduce that client's taxable estate, hence leaving more for their heirs, like a beloved nephew for instance.
If your 3 beneficiaries in life are your family, charity, and the government, I can't think of one sane person who'd choose to leave less to their family and more to the Tax Man.
These ideas are not absolutes -- just rules of thumb I use everyday.
One has to take special needs (handicapped children, for ex.), tax implications, and the future of pensions and social security into account.
Not to mention, the soaring costs of a decent college education. A life insurance policy will send junior to college even if a 529's funding is never completed.
Ultimately, life insurance is used to replace lost income.
And that's what those seeking it should focus on.
dan Homepage 06.22.05 - 2:49 am #
Thanks for your excellent comments, guys. A place to exchange ideas was what I had in mind when I started AllThingsFinancial.
Tags: Life Insurance, Calculating Life Insurance Needs
The first response came from Jim at Accountability is King:
JLP,
A couple of things to consider:
It is usually cheaper to pay all of your debt off with life insurance leaving your family with no monthly debt payments. Remember, though, to adjust your annual income needs accordingly. If there is no mortgage anymore, don't insure yourself for that monthly expense. Reduce your monthly income needs accordingly. One way people commonly end up over-insured is that they forget the cost of living will go down substantially once all debt is paid off.
Also, I am an advocate of carrying the bare minimum in insurance. What I mean is to cover all bases just like you've said, but never round up or estimate. Get the numbers down cold and then do your calculations. Where you rounded to $1M, I would only buy exactly 978 units (a unit being $1,000). There are insurance companies that will sell exactly the number of units you need. Save as much as possible and invest the difference into a fund that moves you toward being self-insured.
Remember, you'll need to be self-insured by the time your term-life policy runs out. Have your advisor figure out how much that will need to be (including a downward adjustment since you'll be debt free by then if the advisor is doing their job right).
Over-insuring yourself seems like a good thing, even honorable. But it bears a substantial cost. Diverting that money elsewhere (debt elimination, or preferably saving to be self-insured) is a better route. In other words, focus on eliminating the burden you would place on your family. Eliminate your debt, create an emergency fund, etc., but do it now. Don't depend on insurance to do it for you. Only use insurance to the extent and for as long as absolutely necessary until the burden you leave has been essentially eliminated.
Once you've achieved certain milestones, reduce your insurance accordingly and again invest the difference. For example, once you've established an emergency fund, reduce your insurance by the amount needed to create one if you had died. Once you've paid off your mortgage, reduce your insurance by the amount you had needed to cover your mortgage if you died.
Your goal is financial independence. That goal is a line on a graph somewhere. Your current situation is another line somewhere below inependence. The only reason to hold insurance is to cover the gap between those two lines.
Over time, your "current" line will move up as your savings increase. Your "independence" line will move down as your debt is paid off. As the gap between the two lines becomes smaller, your insurance should become smaller as well.
Summary: Don't give insurance companies any more money than you absolutely have to. Invest the rest for the benefit of your heirs.
Jim Voigt Homepage 06.21.05 - 3:14 pm #
The second response came from Dan at Catablast:
What I tell my clients with kids is that they should take thier annual income and multiply it by the # of years until the youngest has left the house, typicaly age 21 (after college).
Clients with spouses but no kids should have their annual income multiplied by the number of years left before the spouse reaches age 65 (retirement).
Single individuals may or may not need life insurance, but it never hurts to take out a small perm policy to cover final expenses and burial costs. Single people with considerable debts -- like student loans -- would not be pleased to see their parents shouldering their bills after they're gone.
If I'm dealing with a single and wealthy individual, they may go for a policy which will provide liquidity for estate planning purposes. Shletered in an irrevocable trust, that policy will reduce that client's taxable estate, hence leaving more for their heirs, like a beloved nephew for instance.
If your 3 beneficiaries in life are your family, charity, and the government, I can't think of one sane person who'd choose to leave less to their family and more to the Tax Man.
These ideas are not absolutes -- just rules of thumb I use everyday.
One has to take special needs (handicapped children, for ex.), tax implications, and the future of pensions and social security into account.
Not to mention, the soaring costs of a decent college education. A life insurance policy will send junior to college even if a 529's funding is never completed.
Ultimately, life insurance is used to replace lost income.
And that's what those seeking it should focus on.
dan Homepage 06.22.05 - 2:49 am #
Thanks for your excellent comments, guys. A place to exchange ideas was what I had in mind when I started AllThingsFinancial.
Tags: Life Insurance, Calculating Life Insurance Needs
posted by JLP | 8:50 AM
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