As a Fiduciary and Certified Financial PlannerTM professional, we believe in holistic financial planning. It is not just talking about investments but also about retirement income, estate planning, tax management, cash flow and debt management, health care expenses, college, and insurance. One of the areas we help our clients with is life insurance. Our financial planners work with our clients to determine if there is a need for life insurance, for how long, and what type might be appropriate. Then Diane Kurek from our Insurance Department helps clients find the right matches, through the process, admin issues with policies and process with a claim.
This article is a beginning conversation on life insurance. The first thing to ask is ‘Do I Need it?’ There are two broad mindsets for life insurance. The first and most conventional way of thinking of it is to cover the financial loss if someone passes away. Let’s call this the financial need reason. The second reason is for diversification of investment options. This article will talk more about the first option, to cover the need if someone passes away.
One thing I often do when I have this conversation with people is ask them, “If you were to pass away, would someone be financially affected by your loss?” Your family would be emotionally affected no matter who would pass away but not everyone’s passing has a severe financial implication. Often times a financial need reason does not exist for a young adult until they start sharing financial responsibilities with another like a spouse when they have the obligation of a mortgage or when they start to have children. For me and my wife, Donna, our life changed considerably when we had our first child, Jacob. Donna decided to work part time to take care of him. At that point, if something would have happened to me, Donna and Jacob would have been financially vulnerable with the loss of my income. 17 months later my daughter, Ava came along and now there were two young children.
At that point and in many families situation, we were most vulnerable to loss because we still had big liabilities like our mortgage, potential day care, and maintaining lifestyle. Additionally, we needed to keep in mind that over the next 18 years we would be saving for college. If one of us passed, there might not be the income to save for college. Finally, in a typical marriage, there is division of labor. Each part of a couple does a lot of uncompensated labor that if that person was not around, you potentially would need to pay someone else to do. Adding up all these things is called doing a needs analysis. Emotionally, there is no way to quantify the loss of someone you love but from a financial standpoint, it is crucial to quantify the financial affect of their loss.
Some basic things that are done to calculate what the need is are the following. One a good rule of thumb is 8 to 10 times one’s salary. That should give you a generalized range. Of course each family is different. Other things could be add up all the debts like mortgage, car loan, and other personal loans. Have at least enough insurance to cover all the debts so that if something happens to one person, the survivor could potentially be debt free. After that then layer on estimated educational (K-12) and college costs for number of children you have. Finally, layer in transition period of at least several years where the family is able to maintain lifestyle without having to make changes. I had a colleague who got cancer and passed away in his 30’s. At the time his wife was a stay at home mom when pre-school age child. I remember talking to her and she said her grief counselor said she did not want her making any changes for at least a year or two. Had my friend not had adequate life insurance, his spouse might have had been financial hardship and had to go to work, sell her house, or do other adverse things. I tell folks if something happens to your loved one you want to spend more time with your family not less.
It is important to do a needs analysis on both members of a couple and determine the financial impact. An underestimated part might be the spouse that has left the workforce due to child care or some other reason. For me and Donna, had something happened to her when she reduced her time in the workforce to take care of the kids, I would have no longer had all the financially uncompensated things that she did as a mom. I would have had to pay for all the care activities. We would often joke that if something happened to her, I would need Alice (homage to Alice from the Brady Bunch). Donna would then tell me, “She needed Alice now.”
Finally, how long do you need it. Once again there are other reasons for life insurance but for the needs analysis. You have to look how long is the need. For most families those needs decrease as their liabilities go down, kids grow up, and their assets grow. For this, term insurance may be a good fit. If the financial needs really never go away such as case with special needs child or estate tax, more permanent cash value may be needed. We hope this helps give some perspective.