Life insurance is an important component of any comprehensive wealth plan because it provides financial protection for your loved ones should you die unexpectedly. It’s one of those things no one likes to think about, but it’s critical that you have the appropriate policy in place to support your family.
The following four questions can help as you begin evaluating the best life insurance policy to meet your specific needs.
Question #1 – How Much Life Insurance Do I Need?
A life insurance policy pays out money upon your death based on the amount of coverage you choose. The amount of coverage you choose will depend on what, exactly, you hope to accomplish. For physicians, it’s especially important to have a life insurance policy that meets your family’s specific needs. Three of the top reasons for purchasing life insurance are:
- To replace lost income for loved ones
- To pay off debt (such as a mortgage)
- To put children through college
Once you understand your specific reason(s) for purchasing life insurance, there are two primary methods you can use to determine the correct amount.
- Multiple of income – This is the simplest method and is done by multiplying your annual income by a certain factor, most commonly a factor between 10 and 20. If you are younger and in your high-earning years, you will want to use a higher factor because you have more years of income potential ahead of you. Generally, as you get older and near the end of your career, you have fewer years of income to replace so your multiple will likely be lower.
- Comprehensive planning – This method uses a computer program to account for a wide range of factors in calculating a survivor’s needs. Those factors may include age, taxes, inflation, growth of current assets, college goals and retirement, just to name a few. Comprehensive planning software can be accessed online or by working with a trained financial professional.
Question #2 – How Long Will I Need the Insurance Funds to Last?
Again, the answer depends on what you hope to accomplish with the funds. For debt, simply match the term of the life insurance policy with the year you expect to pay off the debt.
For income replacement, your financial plan can illustrate how much you need today as well as how many years it will likely be until you have accumulated enough assets to close any shortfalls so you that you will no longer need life insurance. Once you have determined when that is likely to be, simply find a policy that meets your timeline.
For example, assume your financial plan predicts you would have a $500,000 shortfall if you were to die today. Then, use the plan to see how long it will likely take for your net worth to increase by $500,000. That is how long you would need your life insurance policy to last.
Question #3 – How Much Should I Be Willing to Pay in Premiums?
A general rule is that you can expect to pay 5 percent or less of your household income. However, the actual premium for coverage varies greatly based on health, age and other factors. The younger and healthier you are, the lower the premium per $1,000 of coverage. If your premium is going to be more than 5 percent of your income, you may need to consider reducing your benefit amount or the length of the term (from 20 years to 10 years, for example).
Question #4 – Should I Consider Buying Permanent Life Insurance?
For physicians, we typically do not recommend permanent life insurance, as we believe insurance should be used for insurance and investments should be used for investing. Instead, we generally advise our clients to use inexpensive term life insurance to get the appropriate coverage over the appropriate number of years, and use their assets to pay down debt, invest for the future and enjoy life along the way.
A rare exception to this rule may apply to ultra-high-net worth families with mostly illiquid assets. Estate tax impacts families who current have, or are on track to have, assets exceeding $23.6 million ($11.58 million per individual) in 2020. The exemption amount has changed greatly over the years and will likely continue to change in the future. However, because taxes are due within nine months of an individual’s passing, it’s a good idea to have a plan in place. For families who have a majority of their net worth tied up in illiquid assets, such as a family farm or business, a permanent insurance plan can be an excellent source of liquidity to cover this type of liability.
Creative Planning understands the challenges you face and takes a team approach to helping you solve them. If you have questions you’d like to ask a qualified fiduciary advisor, please schedule a call.