On today’s White Board series, I want to talk about life insurance and how it should fit into your overall financial planning strategy. No one likes talking about life insurance. It’s a morbid topic, it’s often confusing and difficult to comprehend and understand. It’s just kind of one of those areas that’s a lot easier to sort of ignore and push off to the side, rather than embrace and deal with. But good life insurance planning is a really important part of any good comprehensive financial plan. So if you can educate yourself on the topic, run a quick life insurance needs analysis and put in place the appropriate coverage, you can then put it out of sight, and check that box and move forward in life with the peace of mind that you’ve addressed this issue. You’ve planned for it and you can go forward in life without having to worry about it or keep kicking the can down the road.
So in its simplest form, life insurance is simply a contract between an individual and a life insurance company, where the individual is going to agree to make premium payments to the insurance company, either a lump sum, or monthly, or quarterly or annual premium payments. In return, the insurance company agrees to pay out a stated death benefit to the beneficiaries of the insured if the insured dies while this contract is in place.
So there are two main types of life insurance. There is term life insurance. So a life insurance policy that’s enforced for a specified term or period of years. So a 10-year term, a 20-year term, a 30-year term policy. The term life insurance and then there’s permanent life insurance. Permanent life insurance is insurance that is designed to stay in force throughout the duration of the insured’s life provided they continue to make premium payments.
So depending on your situation, there are some reasons for permanent life insurance, but for the vast majority of people out there, their life insurance needs can be solved by putting in place simple, inexpensive term life insurance. I’ll explain more about that in a second. So now we know what life insurance is. We know a few of the different types, so who needs life insurance? Well, there are a few reasons for owning life insurance, but by far the most common is for survivor need. So if you’re an individual and you have dependents underneath you, or you have financial obligations that go beyond your life and you are not yet at a point where you’ve built up a sufficient level of assets to provide for those survivors if something that happen to you, then you’re likely a candidate for life insurance. There are other reasons that aren’t just for survivor needs like liquidity or estate planning purposes, but for the vast majority of people out there, it’s simple survivor needs.
So when does that present itself? Well, for a lot of people out there, survivor needs comes with either getting married and/or having children. So this might be the first milestone or life event for an individual where they have financial responsibility or obligations for other individuals. At this point in their life they might be young and just starting out and in the process of building up their assets, so they don’t yet have sufficient assets to provide for their dependents if something were to happen to them. So their life insurance need is sort of triggered at this event right here.
So let’s say for this example here, this is someone in their mid to late twenties, they’re in the process of starting a family and they’re just starting out in their career. Now they know they need life insurance. Well, then they need to determine how much life insurance do I need? So this is completely dependent on each individual situation. What your current balance sheet looks like, what your kind of income and legacy objectives are for your survivors, what that time horizon is. But you can take all of those variables and sort of run a good life insurance needs analysis and come up with a pretty accurate number for what that death benefit should be at this moment in time, or at least for the foreseeable future.
So let’s say this individual goes through the exercise of looking at what they have, what the type of income and legacy they want to provide to the survivors, what that duration is. They determine that they need $2 million of life insurance coverage in order for them to sort of fill that gap as of now in life. So they know they need life insurance, they’ve run analysis to determine how much life insurance. Now you have to explore, well, what’s the most appropriate vehicle to put this type of life insurance in place? So they can look at term life insurance, or they can explore permanent life insurance. As I said, for the vast majority of people out there, their life insurance needs can be solved with just cheap, inexpensive, simple term life insurance.
So in this case here, let’s say this Individual is in their mid to late 20s. We’ll look at the time horizon throughout their life out to age 90 and they might determine here that they have a 30-year window of their life up to their age 55 where they have a life insurance need. So they could explore putting in place a 30-year term life insurance policy for $2 million that is going to provide a death benefit to their beneficiaries and to their family of $2 million over the course of this 30-years provided they keep making the premium payments.
So when you put in place a term life insurance policy, they’ll look at your health history, sort of run an actuarial table, look at things like life expectancy and all of that and they’ll quote you a fixed premium. As long as you make that premium payment throughout the duration of this policy, the death benefit will pay out. So this is one way to sort of cover this window of time, where you have dependents and you’re still in the process of building up your assets. Then at the conclusion of the term, likely at this point of your life, your dependents are sort of off the bank roll, they might be off on their own. At least most of your child rearing years are in the rear view mirror and so you have less future expenses.
Then also, hopefully over the course of these few decades, you’ve put in place a productive and efficient savings investment strategy and you’ve built up your balance sheet to a point where at this point of your life, you simply have no need for life insurance. The policy drops off and you can live the rest of your life without the need for any life insurance. Because at that point, there’s just not a need for it and continuing to direct premium payments to insurance companies at that point in your life might not be the most efficient use or productive use of your assets. The older you get and the closer you get to these years, the more expensive life insurance is. So this is just one example of how someone early in their life might solve their life insurance need. Determining they have one, determining the amount and then putting in place a vehicle to solve for that.
So, one other example that could solve this with term life insurance would be instead of a 30-year $2 million policy, they might put in place a 20-year policy for a million dollars and they would put another 30-year policy in place for that same $1 million. They might do this because these two policies, because they don’t cover a full death benefit of $2 million [inaudible]. This might be a little bit less expensive and for 20-years of this term, they’ll have $2 million of coverage, but they’ve gotten older, they’ve built up their assets. They have less years of dependents, years behind them. So these last 10 years, you only have a million dollars. So this is another way to solve it by sort of staggering different term life insurance policies. Again, it completely depends on what your financial situation is and what your goals and objectives are. But these are just a couple of different ways that one can identify a life insurance need, identify what that amount is and solve for.
So as I said at the start, there are some reasons where permanent life insurance might make sense. So that’s, again, making sure that you have life insurance in force throughout the duration of your life. So some of those reasons might be you are a high net worth individual. So someone that has an asset level that’s well above the federal and state tax exemptions, and at their death they might owe estate taxes and they want to put a policy in place to provide liquidity for that. So that might be a reason.
There are certain business owners that might require some form of permanent life insurance, again, for liquidity purposes or for things like buy sell agreement with partners, tax planning things like that. Then there might be some situations where parents have kids with special needs and they’re going to be dependent on their parents throughout their entire life, and the parents just have a lot of comforts of wanting to maintain a life insurance policy and having that death benefit throughout their life.
So those are some examples where you might want to continue some form of life insurance coverage over these years. But as I’ve said a few times, simple, cheap inexpensive term life insurance can solve a lot of life insurance needs for most people out there. Again, at this point, there’s simply no need for additional life insurance beyond that point of their life. So life insurance, a real grim, unpleasant topic. A lot easier to sort of just push off to the side and ignore, but it’s a very important part of any comprehensive financial plan and the sooner you sort of engage it, and embrace it, and put it in place the more peace of mind you can have. Insurance is going to be less expensive the sooner you put it in place in life and so you can lock in some cheaper premium payments.
You might develop some health issues the more you push it off that made you less insurable. So again, there’s a number of reasons to embrace the topic, educate yourself on it. As I said at the start, once you do that and put it in place, you can sort of set it, forget it, and then put it out of your mind and go forward in life with that peace of mind of knowing that you’ve planned for it. So as you put together a comprehensive financial plan that looks at savings investing, and tax planning, and estate planning, don’t forget that insurance piece because although unpleasant, it is just as important a topic as any across your entire financial landscape when you’re putting in place a good comprehensive financial strategy.