A financial planner colleague of mine was recently lamenting the fact that his clients don’t appreciate the value of life insurance. “They don’t get it,” he said. “When you buy life insurance, you’re buying peace of mind!”
But he’s only partly right. Yes, one of the benefits of being properly insured is the peace of mind of knowing that if you die prematurely, your family will be taken care of financially. But let’s be honest - the most important benefit of life insurance is the death benefit – the money that can take financial pressure off your spouse, give your family the option of staying in their home, ensure that your kids will have the opportunity to go to college and address any other goals that are important to them – and you – if you die prematurely. At the end of the day, your life insurance isn’t really about you – it’s about taking care of the people you love. That’s why buying life insurance is one of the most unselfish decisions a person can make.
What is the right amount of life insurance?
Unfortunately, more so than with any other area of financial planning, people – including some financial advisors – rely on rules of thumb and one-size-fits-all formulas to determine how much life insurance is appropriate. The most frequently cited of these shortcuts suggests purchasing coverage equal to 5 to 7 times one’s income. Though this is without question a far better approach than not purchasing life insurance at all, it fails to take into account the unique circumstances and needs of every family.
A better approach is to conduct a thorough “survivor needs analysis” in order to determine exactly what debts survivors would need to pay off and exactly what assets or income they would need to meet their needs in the event of a family member’s death. The objective of such an analysis is to identify all significant needs and assign a dollar value to each. At that point, a comprehensive “risk management” plan that delivers the right amount of dollars at the right times to the survivors can be prepared. If you haven’t been through this exercise before, or if it’s been awhile, talk to a qualified financial advisor. People’s insurance needs typically change as they move through different life stages.
What is the right type of life insurance?
There is a broad – and somewhat confusing – array of life insurance policies available in the marketplace. But there are really only two primary types of life insurance – temporary and permanent. And once you understand that, it becomes much easier to select policies that fit your family’s needs. Simply put, temporary – or term - insurance, is best for covering temporary needs; and permanent – or Whole Life – insurance is best for covering permanent needs.
A term life insurance policy provides a specified death benefit to the designated beneficiary or beneficiaries if the insured dies with the term – or period of time – defined by the policy. So if you have two children, ages 8 and 10, and your priority is to ensure that they will be able to attend college even if you die and are not around to pay their tuition, your best option is probably a 15 or 20-year term policy that provides coverage equal to your best estimate of their total tuition.
A permanent life insurance policy provides a specified death benefit to the designated beneficiary or beneficiaries when the insured dies – whether that’s next year or 50 years from now. So if your spouse doesn’t work and you aren’t on track to accumulate a significant amount of money for retirement, you should give serious consideration to purchasing flexible Whole Life coverage whose proceeds could be used to pay off debts, pay for final expenses, or be invested for the purpose of generating income.
Summing it up
There are a couple of additional points you should keep in mind when insuring your family’s future. First, Whole Life insurance generally makes more sense for someone who is young and healthy – because that’s when you can lock in the lowest premiums. Second, it’s more important to buy the right amount of coverage than the right type. So if your permanent needs exceed your insurance budget, buy less expensive term insurance that can later be converted to Whole Life to fill the gap.
Finally, if you know, or even suspect that your current coverage isn’t sufficient to meet your family’s needs if you die unexpectedly…don’t do what so many other do and tell yourself you’ll get around to it later. Consult an independent financial advisor who can evaluate your needs and prescribe an affordable, high-quality solution. You’ll walk away with the peace of mind that comes only from knowing you’ve done the right thing for the people who matter most to you.
Marc York is a Registered Principal of First Command Financial Planning, Inc.
First Command Financial Services, Inc., is the parent of First Command Financial Planning, Inc. (Member SIPC, FINRA), First Command Insurance Services, Inc. and First Command Bank. Financial planning services and investment products, including securities, are offered by First Command Financial Planning, Inc. Insurance products and services are offered by First Command Insurance Services, Inc. Banking products and services are offered by First Command Bank. In certain states, as required by law, First Command Insurance Services, Inc. does business as a separate domestic corporation. Securities products are not FDIC insured, have no bank guarantee and may lose value. A financial plan, by itself, cannot assure that retirement or other financial goals will be met.