Life Insurance – An Honest & Down-To-Earth Q&A Session – Pt. 2

Now, Where Were We?

Hello there. Thanks so much for reading my blog. As this post is a continuation from last week’s post, if you haven’t had a chance to read it, please take a look at it here. I will now continue my “self-interview” on all things involving life insurance.

We get it. You are a big proponent of having insurance – either in the form of term and/or permanent coverage.  But how much is enough?  How does one determine how much insurance he/she needs?  How much should be in term?  How much should be permanent?

Answering such a question is highly subjective.  I mean, life insurance is such a personal purchase, and it is the most unselfish thing that you can buy for the people you love, that I often struggle with the question regarding “how much is enough” or “how much should I buy”.  That is exactly why I engage clients in planning – so I can listen to them, understand their goals, get a sense of their value system, and try to serve as a guide and resource in helping them find the right balance of protection to meet their needs.  Simply saying “7-10 times salary” doesn’t do the planning process any justice.

How much do you need?

So, in trying to answer this question I often do my best to ascertain answers to the following two financial questions: (1) how much is financially needed immediately upon your death and (2) for the foreseeable future, how much is financially needed to meet the shortfall in financial needs due to your death.  Then you add (1) and (2) together and subtract the sum of: (3) existing life insurance, (4) social security benefits (if any), and (5) any assets that you currently have in place to meet the needs of (1) and/or (2).

Immediate Needs are financial needs/wants that you want to take care of within 12 months of your death.  These items include (1) final burial costs, (2) medical bills, (3) satisfaction of joint debts, (4) fully funding of college fund for children, (5) fully funding of emergency fund for family (i.e., one year of after-tax earnings), (6) optional pay-off of major family debt like a mortgage/student loans of surviving spouse, etc., and (7) funding a “surviving spouse grief fund” (funds adequate to pay for the surviving spouse’s time off from work or change in work, as applicable).

Future needs are a little more complex and oftentimes requires a financial calculator of some sort, but I will try my best to be simple.  In looking at future needs, I take the lost financial resources (salary, retirement savings, asset accumulation, etc.) and compare that to the resources needed under the new plan (one where a financial provider is gone, but there remains to be needed for household maintenance, child care, college planning, retirement planning, etc.).  This often entails multi-stage analyses when dealing with young children (where Social Security can be contemplated), teens and college-age children, and the surviving spouse as a pre-retiree and retiree).  Those needs are then computed into an amount needed now to fund the shortfall, which is the Future Needs component of life insurance.

Next, you add the Immediate and Future Needs to arrive at the Tentative Need.  Finally, you subtract the combination of Social Security your surviving family is expected to receive, existing life insurance, and existing assets (in place for the purposes that the insurance is intended to be used for) from the Tentative Need to arrive at your Insurance Need.  This is not the easiest stuff to come up with.  Thank goodness that there are calculators on the web and trusted professionals out there that can assist you in the process.

In determining what amount should be term coverage vs. permanent coverage.  It’s highly subjective, but I generally recommend that families use the “temporary need for term, ongoing and changing need for permanent” approach.  For instance, let’s say that my total insurance need is $1.5 million, made up of an immediate need of $500,000 and a future need of $1 million.  However, when I drill down deeper into my future need amount, I see that $700,000 is needed to fund financial shortfalls needed only while my daughter is a child up to and through her graduation from college.  After college, there is no longer such a need.  Therefore, in this instance, structure my $1.5 million life need as $1.2 million in 15- or 20-year term, and $300,000 in permanent life coverage.  Also, as term has conversion features, I might buy $1.5 million in 20-yr term and at the end of my childcare need period, convert $300,000 of my aforementioned term insurance into permanent coverage and drop the $1.2 million term coverage.  The point is, that once the need is determined, there are many ways to go about securing it.  No one way works best for everyone.

Lastly, this analysis is representative of how I derive insurance needs with a majority of clients that I service.  It should be said and made clear that everyone’s situation is different.  With that said, it is not my aim to tell you that the approach that I described is the best way that works for you and your family.  There are many different situations – families with children who have disabilities/special needs, breadwinners with generous pensions, or a married couple with no children, but provide for parents/other loved ones, etc.  The list goes on and on, but the point to drive home is that different facts, circumstances, makeup of net worth and makeup of existing coverages impact the calculation and derivation of the amount of insurance needed (if any) as well as the structuring of such coverage (i.e., the term life vs. permanent life, or combination of the two).

Stay Tuned. There’s more to come.

Please come back next week for the final part of this discussion on Life Insurance. I hope that the information shared is helpful to you and those that you love. As always, feel free to contact me via Facebook or Twitter to ask questions or discuss the topic in more detail. Thanks!