Friday, October 24, 2008

It’s about the money, not the death

During these days, it is hard to focus on things other than what is going on in the larger economy. One day, stocks are up. The next, stocks are down. One day, we wonder if the banks are failing. The next, several appear to have been anointed as survivors in our experiment in quasi-socialism. Regardless, let me venture into a more mundane topic: Life Insurance.

When you are considering life insurance you have to answer four questions:

1) Do you need life insurance? This one is simple. If no one will be worse off financially after you die, you do not need life insurance. Let me write that again, If no one will be worse off financially after you die, you do not need life insurance. Life insurance is designed to provide income to your financial dependents, if you experience an untimely demise. OK, so your funeral is an expense and you don’t want that to burden your parents, or others. Well, a funeral is a great time to use your emergency fund and, from a financial point of view, if your parents support you, they might be better off financially – even after paying for your funeral – if you’re dead. Don’t think of this as harsh and NEVER think that they would choose to have you dead, as opposed to having you with them. The point is that your parents will be emotionally, not financially, devastated if you should die. Life insurance is about the money needed by dependents. It is not about the tears they must shed. It is a financial decision, not an emotional one.

2) If you need life insurance, how much? This is conceptually simple, yet complex to calculate. You want to provide enough financial resources to provide for the desired level of living for your surviving dependents. Typically, this is less than what it would cost if you were still eating and going to movies with them. A simple way to think of this is to take a level of income for the time of dependency, perhaps add college costs, loan repayments, or other known expenses and provide life insurance proceeds that are equal to the present value of these needs, less any resources that you already have like savings and Social Security benefits for the survivors. You say, “HUH?” Maybe you should try a calculator like: which is from LIFE, a non-profit organization.

3) What kind do you buy, if you need life insurance? Often the answer to question #2 dictates the answer to question #3. If you have a large life insurance need, often term insurance is the only type a family can afford. Term insurance is pure insurance and the protection is provided for a term of time; one-, two-, five, or twenty-years. At the end of the term, the policy can be renewed if it is guaranteed renewable. (Always buy guaranteed renewable term, in case some dread disease strikes prohibiting you from purchasing insurance.) Other kinds of insurance policies have a savings element that is a part of the policy and can typically be owned throughout one’s life….if one needs life insurance for their whole life. If you have a large estate at death that is subject to estate taxation or if you have a large lumpy asset that you want to preserve, like a farm or business, a permanent, “life-long” life insurance policy might very well be what you need. (We’ll write more about types of policies in a future “Tip”.)

4) How do you want the proceeds paid out, upon death? This is easy. Most people take the money as a lump sum and invest it in other assets, as they spend it as it was intended. On the other hand, it is possible to leave the money with the insurance company and purchase an annuity contract to provide income over time. This choice can be made by the policy owner, if alive, or by the beneficiaries at the death of the insured.

There is much more that can be said about life insurance. It is, however, much easier to make life insurance decisions if you follow a set of questions and do a complete, objective analysis. One thing I often recommend to those that answer the first question in the affirmative is to visit several life insurance sales persons, or web-sites, and see if you receive a similar answer to “How Much?” from several, if not all, sources. If so, I’d recommend you begin to believe the answer and to then chose the vendor that has financial strength, A or A+ rated, and that has a record of customer service. Check with your state Division of Insurance for more information on agents and companies, as well as to read their printed information to increase your chance for Financial Success.

NOTE: If you’ve questions or suggestions for future Financial Tips, do not hesitate to send an email to my gmail account . I do not plan to answer individual questions, as we’re not a chat room, but I will try to work an answer into a future financial tip. Please put Financial Tip in the subject line, so I know it is not spam. Thanks.

- Robert O. Weagley, Ph.D., CFP(r)

Chair, Personal Financial Planning

University of Missouri

Columbia, MO 65211

1 comment:

K said...

Thanks for your article. It's good to know as much as possible about life insurance . It's sometimes confusing and it's good to know details about it.