There is no getting around death. You will die. I will die. Most of the time, we hardly think about death. Usually the idea of our own mortality is forced into our minds when someone close to us passes away. This is normally a fleeting thought, replaced by real life responsibilities, work, and more pressing engagements. But the reality is, we just don’t like thinking about death. Because the topic of life insurance forces us to think about our death, we correspondingly don’t like thinking about life insurance. It’s just not fun to do. But, it is necessary to think about such insurance, especially if you have a family who depends financially upon you as a breadwinner. Not dealing with this responsibility means you are exposing your family to the risk of becoming financially destitute if the unthinkable happens. No matter how hard we may want to avoid dealing with death, we simply must address our financial responsibilities to those we leave behind.
Risks Covered By Life Insurance
Life insurance may be used to protect against many different types of risk, both personal and business related, such as:
1. Regular Life Insurance – Proceeds from an insurance policy used to replace lost future personal earnings due to an untimely death. The face amount (aka “coverage amount”) required to meet this need depends upon several factors, which include lost earnings, monthly housing costs, other assets available etc.. A simplified approach, that allows you to get a ballpark idea of the coverage required, is to divide your annual earnings by 5%. For example, if your annual earnings are $50,000, you would need $1,000,000 in insurance coverage ($50,000 divided by 5% equals $1,000,000).
2. Buy-Sell Life Insurance – Proceeds from an insurance policy used to acquire a deceased business associate’s interest in your business. The face amount required to meet this need depends upon the fair market value of your business multiplied by your deceased associate’s ownership interest in the business. For example, if the value of your business equals $1,000,000 and there are two associates, this requires insurance on each associate equal to $500,000. The business may be the owner/beneficiary/payor of premiums for the life policy or each associate may be the owner/beneficiary/payor of premiums.
3. Key Man Life Insurance – Proceeds from an insurance policy used to secure the services of a deceased employee with unique skills. The company is the beneficiary of the plan and therefore pays the insurance policy premiums. Key person insurance is needed if the sudden loss of a key executive would have a large negative effect on the company’s operations. The payout provided from the death of the executive essentially buys the company time to find a new person or to implement other strategies to save the business.
4. Second-To-Die Life Insurance – This is an insurance policy that insures two lives (you and your spouse). If the last spouse to die has a taxable estate, the proceeds from this insurance policy will be used to pay for the federal and state estate tax. For example, if the future estate is projected to generate an estate tax of $1,000,000, then you would want a face amount equal to this amount. This ensures that your heirs receive every dollar of your estate.
5. Wealth Transfer Life Insurance – Proceeds from this type of insurance policy are used to leave a bequest to a charitable organization of your choosing.
Types of Life Insurance Policies:
1. Term Life Insurance – Term life is “temporary” insurance. It provides for pure annual coverage only (no investment component as in other types of policies). On the death of the insured it pays the face amount of the policy to the named beneficiary. The younger you are the cheaper term premiums are. On the death of the insured it pays the face amount of the policy to the named beneficiary.
2. Whole-Life Insurance – Whole life provides “permanent” insurance coverage and allows you to create an quasi-retirement investment account which is tax deferred. This policy will remain in force for your entire life so long as you make the required premium payments. It is more expensive because a portion of your premium is used to create an investment asset known as cash surrender value. This cash surrender value accumulates tax-free, unless you terminate the policy before death.
3. Universal Life Insurance – Universal Life is another type of “permanent” insurance. Universal is more flexible than Whole-Life offering low-cost permanent insurance protection as well as a savings element which, like Whole-Life insurance, is invested to provide a cash value buildup. The death benefit, savings element and premiums can be reviewed and altered as a policyholder’s circumstances change.
4. Variable Life Insurance – Variable Life is similar to Universal Life except that it offers a greater array of investment choices.
5. Whole Life Insurance With Accelerated Death Benefits – This is a Whole Life Policy that allows you to withdraw your Death Benefits, expressly to cover Long Term Care costs. Typically, these Hybrid Whole Life Policies require that you be unable to meet two out of five activities of daily living (Bathing, Dressing, Eating, Toileting and Transferring/Mobility). Amounts withdrawn can cover Skilled Nursing Care, Home Care, Assisted Living and Day Care Facility.
To summarize there are four basic principles to consider when evaluating life insurance:
1. Determine your needs.
2. Understand the different types of policies available.
3. Determine which policy best meets your needs.
4. Review your insurance as your needs change.
5. Select a professional who specializes in life insurance.
Tom Corley is an accountant, financial planner and author of “Rich Kids: How to Raise Our Children to Be Happy and Successful in Life”, “Effort-Less Wealth”, “Change Your Habits Change Your Life”, “Rich Habits Poor Habits” and “Rich Habits: The Daily Success Habits of Wealthy Individuals.”