Along with estate planning, insurance planning is likely another wealth planning topic that most people would rather not talk about. I believe that there are a few reasons for this;
If you can find an advisor to work with that you trust and who places your interest before theirs, I think that most people can get past the first two points. In this piece, I want to provide you with the knowledge to understand the who, what, when, where and how of life insurance products so that you can make the best decision for you and your family when integrating insurance planning into your wealth management plan.
There are six main reasons for having Life Insurance:
How Much Life Insurance is Enough?
There are two primary approaches to determining the amount of life insurance that an individual or a family might need.
I use and prefer the needs approach. I have found that trying to value a human life is somewhat tricky and not as straightforward as it may seem. Also, this method usually tends to require more life insurance, which is costlier than what you may need. By building a base case from what you may need, it helps to open up what goals should be planned for which previously may not have been thought about or discussed.
Types of Life Insurance
At its root level, there are only two types of insurance, temporary and permanent. As you will see, term insurance has immense flexibility with the length of a policy or need while there are various forms of permanent policies as well.
Term life insurance provides death benefit coverage over a fixed term of time such as 10, 20, or 30 years or any year in between. You should think of term similarity to your homeowners or renter’s insurance. It is there when you need it, but you still pay for it even when you do not. It has no cash value except at death. If you die after the term expires, your beneficiaries get no payout.
Term premiums are much less than permanent life insurance because you are only seeking coverage for a specific amount of time vs. your entire life. However, most term policies can be converted to a permanent policy at a later date. The owner of the policy can cancel the policy at any time, but your policy cannot be canceled due to poor health.
Most term policies are fixed policies in which case the annual cost of your policy is the same each year over the life of your policy. Your premiums will never go up, which is another reason to lock in your insurance policy when you are young. Additionally, your policy automatically renews annually.
If your term life insurance is purchased through an employer, your insurance coverage will most likely end when your employment ends. This is one reason why I encourage you to consider owning your own term policy. Like any life insurance policy, term insurance gets more expensive as you age. For example, if you have insurance through your employer and ten years later you change companies and need insurance, that insurance just got a whole lot more expensive. Also, most employee insurance plans can cap the dollar amount of coverage, which may be less than you need.
Overall, term insurance is best used when you have a known specified length of time and a significant amount of insurance need. For example, a young family with multiple financial priorities would find it difficult to get adequate coverage for their needs which could include income replace, paying off debts/mortgage, and funding future college education expense. Term insurance would allow them an affordable option during the years that their children are growing up.
Permanent life Insurance provides continuing coverage for the insured’s entire lifetime (if the premiums are paid), rather than for a set number of years as with term insurance. The annual premiums stay fixed, and at death, it pays out a lump sum death benefit.
Premiums on permanent policies are much higher than term, because the policy is designed to last a lifetime, and it builds up cash value on a tax-deferred basis. If you cancel the contract, you will get paid your cash surrender value, but if you have any gains, they will be taxed as ordinary income.
As I mentioned previously, there are several variations on Permanent Life Insurance:
Overall, permanent insurance can be a useful planning tool for legacy and gifting planning in addition to the previous reasons we discussed as to why most people need life insurance. Permanent insurance can also be utilized for tax and retirement planning purposes given their current tax advantages.
In summary, I would like to make a few final points when it comes to life insurance;
Consider this an introduction into the world of life insurance planning. Given the uniqueness of any one particular wealth planning case, there could be various solutions utilizing the different forms of life insurance that were covered. However, understanding the essential features of these potential tools can have a lasting impact on both your financial and lifestyle goals.
For questions about any wealth planning and asset management topics, do not hesitate to contact me to find out what options may be best for your situation.