Life Insurance is one of those subjects that conjure up the need to take a Zantac primarily because it reinforces the adage that the only thing certain is death and taxes. Nobody likes to talk about mortality, especially his own, but it is a subject that needs to be addressed by all people. Even though needs may change, the need for owning life insurance does not. In this article, I am going to discuss three scenarios regarding life insurance, single people with no dependents, married people with dependents, and an older couple (empty nesters) with a need for insurance due to having an estate tax liability.
Before I address the three scenarios,
there are a few items I would like to discuss about insurance in general. First, it is a rare instance that I would recommend anything other than term insurance. With term insurance, you are strictly paying for coverage. It is sold in “premium guarantee bands”, usually ten, fifteen or twenty years. Make sure the policy is not conditionally guaranteed for the entire period. A conditional guarantee means the company can increase the premium after a certain period of time. Make sure the policy you buy is fully guaranteed for the premium guarantee period. As you might expect, a shorter guarantee period costs less than a longer guarantee period. Term Insurance does not have a “savings element”, or cash value, associated with the policy…it is for protection only. Universal Life or Whole Life insurance does have a “savings element” affixed to it and would be decidedly more expensive than term. If you have invested the maximum amount in your 401(k), have adequately funded 529 plans definitionand have proper savings and little debt, then you may want to look into Universal or Whole Life insurance. Until then, purchase term insurance because it is with this that you can buy the largest amount of insurance for the least possible cost. Two other points to remember: any life insurance proceeds received are received income tax FREE. In addition, by having a named beneficiary, proceeds are paid quickly and privately without having to go through a lengthy probate process. Please note if an insurance policy has an incontestable clause (usually two years), the company has the contractual right to investigate any claim. Once a policy is two years old that right disappears, unless they can prove fraud at the time the application and accompanying medical exam were secured.
If you are single,
have little debt and no dependents, there are few circumstances that would warrant having an abundance of life insurance coverage. For a single individual, I would dwell more on disability insurance to make sure your income is protected and long term care insurance to make sure you have proper funding in the event of illness and the infirmities of old age. Typically, any group life insurance you may receive from your employer would suffice. These amounts are normally a flat amount ($25,000-$50,000), or a multiple of your compensation. For example, if you earn $75,000, your group life might be twice your salary, or $150,000. If your estate were in excess of $3,500,000, you may want to have life insurance to pay any estate taxes. For the majority of individuals, this is a moot point.
For married people,
especially if there are children involved, having the proper amount of protection is a cornerstone of any viable plan. There are many rules of thumb for calculating the proper amount of insurance. One method is to use a “five times income” calculation. Another would involve taking the present value of any education and housing needs, determining a viable amount of income which may be necessary, and through a more comprehensive needs analysis, arriving at a figure which is reasonable. If both husband and wife earn in excess of $100,000, along with a mortgage, income, and education liability, it is not uncommon for each spouse to have at least $1,000,000 of coverage through the income dependency period. The goal of any insurance is to make sure that you can remain in the world that has been provided for you…nothing more and nothing less. A life insurance professional with a CLU (Chartered Life Underwriter) designation is normally qualified to provide proper counsel. Most, if not all, insurance professionals work on commission and are only compensated on the products they sell. There are very few, if any, fee only insurance people. Please ask your insurance professional for clarification.
Once children have grown and education costs have been amortized,
life insurance may have to be used to pay for estate taxes. As the law currently states, and this should change by the end of 2009, there is federal estate tax due if an estate is valued at more than $3,500,000. Before any property can be transferred, the tax must be paid. If there is insufficient liquidity to pay the tax, assets must be sold in order to pay the liability. Life insurance, as it is received income tax free, is the best way to pay any estate tax liability. The use of “second-to-die” insurance, as well as the use of an Irrevocable Life Insurance Trust, is the most cost effective way to satisfy this obligation.