Preparing for When Life Happens
One of the advisors in our office was previously employed at an insurance agency. He’ll never forget the day that a client in his forties came in to the office, sat down at the desk, and announced that he had terminal brain cancer. A few months later, that client passed away. He left behind his wife and two young children. Fortunately for them, he had purchased adequate life insurance to help provide for them in his absence.
Thinking about life insurance is something most people don’t want to do. Contemplating one’s death is a scary thing for most individuals and some people may even find it debilitating. We wanted to highlight the importance of life insurance and also provide some useful information if you need to obtain this important coverage for you and your family. Below you will find four things to remember when you’re reviewing and obtaining life insurance coverage for your family.
#1 – Why Do Individuals Need Life Insurance
There are three primary reasons why individuals could need life insurance: income replacement, estate liquidity, and leaving a legacy.
Income replacement is by far one of the most important reasons to obtain life insurance. Whether you are young or old, if you provide financially for your family (whether through earnings, a retirement pension, or other form of income) and your family will need to replace lost income in the event of your premature death, you need life insurance.
Estate liquidity is needed for individuals whose estate assets are illiquid. An example would be an individual who has several heirs and they own a large amount of real estate or a business. In the event of their death, it may be difficult to split an illiquid asset such as real estate multiple ways. Life insurance can also be helpful if your estate is large enough to trigger estate taxes. Your family may not want to be forced to liquidate certain assets to pay taxes, so the life insurance benefit would be helpful in this situation. Note: due to current estate tax law, most individuals’ estates will not be subject to estate tax.
Some individuals may not have an estate to pass on to heirs, but they may want to ensure that they leave a legacy for their family and friends. An example would be a grandparent who wants to make sure the college education for their grandchild is paid for. Life insurance can provide the means to accomplish this goal.
Depending on an individual’s circumstances, there can be other reasons to purchase life insurance including final expenses, covering a business need (like a buy/sell agreement), and more.
#2 – Term vs. Permanent Insurance
If you need life insurance, you will need to go to a licensed insurance agent in your state to purchase coverage. Depending on the agent you’re speaking with, you’re likely to hear the words “term” and “permanent”. Knowing in advance what these terms mean can be helpful.
Term life insurance refers to coverage that lasts for a set number of years, such as 5, 10, 20, or 30 years. Generally the premium is level for the entire selected policy period. Because the coverage is designed to be for a limited time period, the cost is much lower and you can get more “bang for your buck”. At the end of the term, you usually can continue the coverage if you would like for a higher premium or cancel the policy. In general, this is a great option especially for those who need coverage for a fixed period of time (say until retirement) and/or need to replace income.
Permanent life insurance involves coverage that lasts your entire lifetime, hence the name “permanent”. Because the coverage has to last your entire life (usually at least until your eighties, nineties, or longer), the premium will be much higher than the cost of term coverage. This type of coverage generally comes in two flavors: universal life and whole life. While the specifics on these policy types is beyond the scope of this article, the important thing to know is that permanent coverage usually has a cash value component that grows over time, it can earn interest, and the policy may receive dividends (a return of premium). This policy type is generally better for needs like estate liquidity or other needs that extend well beyond a typical term policy.
#3 – Don’t Underestimate How Much Coverage You Need
Many employers will provide some type of group life insurance benefit equal to one to three times your salary. It’s common for individuals to assume that one to three times your salary is going to be sufficient to provide for your family in the event of your death. This ignores the actual value your income may provide to your family, especially if your salary is the only source of income.
For the average 30 year old making $75,000 per year, if they plan to retire at age 65, they will earn $2.625 million during that time period. If that person has a spouse and children who rely on their income to pay expenses, having only $100,000 to $200,000 of life insurance through work is going to fall short of that family’s actual need. As a general rule, at least eight to ten times your current salary is a good starting place for how much coverage you need. The actual amount of coverage you need could be much higher or lower depending on your individual circumstances.
#4 – Beware of Sales Tactics
You may wonder how the insurance agent gets paid for the work they complete for you. The answer is most if not all life insurance agents (or the agency they work for) earn a commission for every life insurance sale they complete. In many instances, the commission could be equal to the first year premium. For the average permanent life insurance policy, this could be hundreds if not thousands of dollars. Naturally, it can be very easy for the life insurance agent to not be aligned with your best interests and use sales tactics to sell you a policy.
The advisor in our office who used to work at an insurance agency witnessed some of these tactics. One tactic his employer recommended was always offering the more expensive, permanent life insurance first before offering term. The reasoning was that you should only offer term if the client balks at the price of the permanent policy.
Another tactic that is commonly used by agents is to tell individuals that permanent insurance is superior to term insurance. Agents will tell you that permanent insurance is an “investment” that has a “cash value” or account balance that grows over time, which term insurance does not. While it is true that permanent insurance has a cash value or account balance that most term policies do not have, it is important to remember the reason why you’re buying life insurance is for the insurance, not the potential to earn a return. With many permanent policies, often the only way to “unlock” the cash value is by surrendering the policy (which may incur surrender charges) or borrowing against the cash value (which will incur interest and reduce the available death benefit). Most individuals are far better off buying term insurance and investing the difference if they want access to their principal in the future.
How River Capital Advisors Can Help
If you are contemplating purchasing life insurance or if you have an existing life insurance policy that you want reviewed, our team of CERTIFIED FINANCIAL PLANNERS™ at River Capital Advisors is well-equipped to help you analyze your need or the existing coverage you have. We do not sell any products nor do we receive any commissions for our recommendations. As fiduciaries we are legally obligated to tell you what is in your best interest.
Additionally, if you need a referral for life insurance, we can refer you to an independent insurance agent that we know and trust to provide you what you need. We have access to low load (low commission) and no commission life insurance through several agencies. These agencies do not work with individuals so we can provide these products to our clients at lower costs than they probably could achieve on their own. If you believe you are in a high cost insurance product of any kind, we can provide a second opinion and potentially move you to a much lower cost product. Please contact us if we can help you.