Till Death Do Us Part
Written by Kyle Olson. Kyle is a Certified Financial Planner™ and QA Managing Director. He is also a partner in the firm.
Death is never an exciting topic to think about. We avoid the thought or discussion at nearly all costs. For the same reason, discussions around life insurance can be difficult ones and often put off. We just don’t like thinking about death. But having appropriate life insurance coverage, especially for someone with a family, is a very important part of a well-rounded financial plan.
I’ve found there are typically two big questions when it comes to life insurance. The first – how much should I have? The second – what type should I consider buying? I will briefly discuss both questions here.
How much is enough?
I’m going to start with more questions than answers here because the answer really depends on your situation. On top of the obvious funeral expenses, you need enough death benefit to cover your family’s needs should you pass away prematurely.
Do you want to replace your income for a period of time? For example, if you wanted to replace a $100,000 income for 20 years, a simple present value calculation would say you might need $1.3 – $1.6 million in death benefit to do so (depending on the assumed yield on the proceeds).
Do you want to provide for currently unfunded college expenses or have a mortgage paid off? This can help your survivors significantly by having these large expenses taken care of. Answers to these questions may then change how much income you may need to replace. If the mortgage was paid off, for example, you may need to provide less for income replacement.
Do you want to plan to have potential projected estate taxes covered? At the end of the day, it’s important first to think through the things your heirs may need to cover or the income they will need to replace with life insurance. After answering all of these, and related questions, you can then calculate the present value of those future needs.
Another consideration is that as you age and kids get older and assets grow, you may make progress toward essentially “self-insuring”, where assets begin to be significant enough to cover income needs, mortgages are paid off, and college is funded through savings.
What type of Insurance?
With most of the income replacement needs discussed above, they have a finite time where the need exists. Because of this, a low-cost term policy is often the best route to cover needs like this. Set the term (the number of years) to end, for example, roughly when the mortgage is paid off, or at a retirement date where presumably assets would then cover income needs.
There are some more complex cases (too detailed to go into here) where permanent cash value policies may be appropriate. These policies are much more expensive but also typically grow some form of cash value. A few examples would be funding estate tax needs, setting up and funding a trust to provide for a special needs dependent, or funding charitable trusts.
At the end of the day, thinking through both decisions can have their complexity. These are questions we help people think through every day, and since we don’t “sell” insurance we feel like we can give sound, objective advice. Let us know if we can help you think through these important decisions.
* Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, Certified Financial Planner™, CFP® (with plaque design) and CFP (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.