Early in my career, I was told that there are two reasons why you buy life insurance. Either 1) you love someone or 2) you owe someone money. This logic has always stuck with me. Ultimately financial planning is motivated out of responsibility, and in this post we will discuss how life insurance is a fundamental building block of a good financial plan.
If you love someone…
There was a commercial during the 2020 Super Bowl for a life insurance company that explained the various Ancient Greek words to describe love. The commercial professed that the most admirable expression of love is “Agape” or what they describe as love as an action. Naturally, the insurance company is implying that the action you should take to show love is to buy life insurance.
Here is how I think about this: When we start a financial plan, we always start out with a discussion about goals. What are we planning for? Both in the short term and long term. Typical goals are to get out of debt, buy a house, save for retirement, pay for a college education or a wedding, etc. We can customize a plan for each of these goals and initiate the right investment plan to get there. However, what if a premature death occurs? Would the goals change? Would you still want your family to be free of debt? Would you want your surviving spouse or partner to retire? Would you want the college education or wedding paid for? Typically, if there are people depending on you while you are alive, you would want the best for them in your absence. This is how life insurance becomes an expression of love.
Understanding life insurance
Insurance in its definition is simply a way of transferring risk to someone else. We are used to this concept with medical insurance or auto insurance. Since we may not have the excess cash to pay for a major medical bill or an auto accident, we transfer the risk of paying for major expenses to the insurance company. Basically, insurance gives us a way to buy a pile of cash to be available when we need it. When it comes to life insurance, we are insuring not only the cost of final expenses (funeral, etc.) but also our ability to earn money.
Our cash flow allows us to pay our bills, provide for the essentials, borrow money, and save for the future. Typically, during our working years, cash flow is dependent on our ability to do a job. So, what if life is cut short suddenly? Would the cash flow stop? If the answer is yes, then life insurance is necessary.
How much life insurance do you need?
A good way to determine how much life insurance you need is to focus on income replacement. Let’s say you earn $100,000 per year and you have 25 years ahead of you in your career. Without any increases in your compensation, you will earn $2.5 million over the rest of your career. A $2.5 million death benefit will provide a replacement for the income that is lost if you die.
Another way to determine life insurance need is to itemize expenses. Here is an example:
Funeral and other final expenses: $15,000
Mortgage Balance: $415,000
Education Fund for kids: $250,000
Wedding/Family Events: $100,000
Fund for Income Replacement ( $100,000 income ÷ 6% interest rate): $1,666,667
Total: $2,446,667
In these examples we arrive at almost the same number, but the process of itemizing expenses can be like a fire drill in that it takes you through the process of actually articulating what you would need if there was a death.
Often overlooked
In my career, I have witnessed the emotional and financial strain that an unexpected death puts on a family. Here are some items that need to be taken into consideration when discussing life insurance:
The tax filing status for a surviving spouse will most likely change from married filing jointly to filing single. Not only will the household lose income from the deceased spouse but may also move into a higher tax bracket. It is important consider taxes, inflation, and cost of living adjustments when discussing income needs.
If qualified, Social Security will pay a survivor benefit to an unmarried surviving spouse if there are minor children in the household. This income benefit will pay until the minor child is 16. When the last minor child reaches the age of 16, the benefits will freeze until the surviving spouse reaches 60 years old.
Medical bills can add up and leave a family with a financial burden after a long terminal illness. This should be considered in the insurance benefit.
The death of a child is devastating, and also can be financially draining. It is important to have life insurance on children.
The process of the death of any loved one can have an impact on performance at work. It is important to consider the time that will need to be taken away from work by the surviving spouse and plan for this financially.
No family has ever said that the life insurance benefit they received was too much. I have had an experience where the surviving wife told me in tears that she had told her husband to buy more. I will always remember the helpless feeling that I had in that moment and I hope that sharing this message will encourage others to be prepared.
No time like now
Like the Super Bowl commercial, MasterCard used to have great commercials that played
on the heartstrings by listing the cost of something sentimental as “priceless.” The tagline was, “There are some things money can’t buy. For everything else, there’s MasterCard.” It is really impossible to put a price tag on a human life. We were all shocked with the news of the basketball star, Kobe Bryant, and his daughter being killed in an accident. For me, like most people, the shock was seeing people so physically healthy and capable being taken away in an instant. It was a reminder for me of our mortality. With that in mind, don’t put off the life insurance conversation. Seeing your loved one walk through the door one more day truly is priceless, for everything else, you need life insurance.
Centered Financial, LLC is a registered investment adviser offering advisory services in the State of California, Utah, Texas and in other jurisdictions where exempted. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. There is no assurance that the techniques, strategies, or investments discussed are suitable for all investors or will yield positive outcomes. To determine which strategies or investment(s) may be appropriate for you, consult your financial adviser prior to investing. Any discussion of strategies related to tax or legal planning is general and is not intended as tax or legal advice. Please consult appropriate tax and legal professionals for recommendations pertaining to your specific situation.
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