I recently spoke with an old friend living near the beach of Melbourne, Florida. He has been concerned, as many folks are, about the health scare related to Covid-19. As an entrepreneur, he is accustomed to addressing issues head on, being resourceful, and finding solutions. Which is why he reached out to me for advice.
He wanted to know more about life insurance and reducing financial risk for his family. With two young sons and a wife, he worries how they would cope in his absence.
Life insurance is a very important topic for your financial planning. Make sure to check out the rest of the series:
Do I need life insurance at all?
If you have dependents such as children, spouse/partner, or aging parents who rely on the income you provide for them, then chances are you may need some type of life insurance. The death benefit from insurance provides a tax free cash payment to your beneficiaries when you die. The cash payment can replace a portion of, or all of, the income your dependents rely upon. However, if you have significant wealth in the form of non retirement investments such as stocks, mutual funds, a significant real estate portfolio, or a valuable family business, your life insurance needs could be minimal.If you invest in real estate or a business and take on debt, consider life insurance in an amount sufficient to pay off the debt. If you have a significant net worth, over $10 million, you may want to consider life insurance to pay your estate tax bill.
At a minimum, you should consult with your financial advisor to determine what amount of wealth or life insurance is sufficient to replace your income.
How much life insurance should I consider?
A simple rule of thumb is to multiply 15 times your annual income. So, if you make $60,000 a year, consider having $900,000 in life insurance.
If you prefer a more precise method, follow the Needs Based Approach. Your goal with the Needs Based Approach will be to cover the expenses associated with the absence of your annual salary, until either your last child is through college or your spouse is near retirement age (around age 67). When estimating the following calculations, use the number of years between now and whichever is further (child vs retirement) to discover your support obligation.
TOTAL EXPENSES: Add up the following amounts
Final expenses: Costs associated with funeral, attorney, medical, etc.
Long-term family maintenance expenses (i.e. living expenses): necessities such as food, clothing, utility bills, insurance, and transportation. Forecasting this expense is easier if you use a budget. Important: Take the annual amount and multiply it by the number of years until you or your spouse reaches age 70.
TOTAL DEBT & OBLIGATIONS: Add up the following amounts
Mortgage: Primary home, vacation home, home equity loan
Outstanding debts: credit card, auto loan, college loans, etc.
Future college tuition expenses
Emergency Fund: Ideally, you’ll leave behind a minimum of 6 months living expenses in cash.
TOTAL RESOURCES MEETING YOUR FAMILY'S NEEDS: Subtract the following amounts
Investments: Stocks, bonds, mutual funds, 401k, IRA accounts
Bank accounts: Checking, Savings, Certificates of Deposit
Existing life insurance: Face amount of all policies you already own
Your ideal life insurance amount is equal to expenses (both immediate and long-term) plus your debts minus your existing resources. If you need help with the calculations above or you do not have sufficient resources to meet your family obligations today, speak with your financial advisor or a life insurance agent.
What type of life insurance should I consider?
We generally advise people to purchase term or whole life insurance. The reason is that both of these policies have a fixed death benefit which is what your dependents receive if you pass away. With whole life insurance, the premiums you pay can be level for your lifetime and will not increase. Level premiums can help you budget and avoid dramatically increasing insurance expenses later in life.
There are two other types of life insurance, known as universal life insurance or variable universal life insurance, which offer flexible premiums and flexible death benefit amounts. We will address these in a future blog post.
How long of an insurance term do I need?
Consider a policy that would take your kids through college and your spouse/partner to their full retirement age (usually age 67 or 70). This can typically be obtained in a cost effective manner using level term insurance or permanent whole life insurance. We will cover these two types of insurance in more detail in our next blog post.
I can help.
Due to the complexity of financial and estate planning, it is important to consult qualified professionals to ensure the life insurance policies you choose are consistent with your immediate and future wealth building, retirement, and family protection needs. As a financial advisor and insurance expert, I can help guide you in your decision making process.
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About the Author
Peter Newman is a Chartered Financial Advisor (CFA) and president of Peak Wealth Planning. He works with individuals nationwide that have accumulated wealth through company stock, ESOP shares, real estate, or running a business. Peter applies his unique background to help clients achieve their specific goals and enjoy peace of mind.
Peak Wealth Planning provides concierge services to meet your wealth management needs. Services include: financial planning, investment management, esop diversification, retirement income, insurance, and estate planning advice. Peak Wealth Planning is a fee-based financial advisor based in Champaign, Illinois, and Fraser, Colorado.