Let’s Talk Life Insurance

Published On: July 30, 2019

Written by: Ben Atwater and Matt Malick

Protecting your family and your financial plan often involves owning life insurance.  The proper amount of insurance should assist your family in replacing lost income, paying off debt, funding education, addressing business succession needs, etc. 

The number one reason to buy life insurance is for income replacement.  If someone is relying on your income, then you probably need insurance.  Companies “underwrite” life insurance to reflect the risk that they are undertaking, so the better your health, the lower your premium.  For younger investors with families, planning your life insurance should be as important as planning your retirement.  And, the younger you are when you start to purchase life insurance, the cheaper the premiums. 

To accomplish income replacement, most working spouses should have life insurance death benefits of five to ten times their total annual compensation.  If a spouse is a homemaker and provides childcare, then you should consider covering him or her at the annual cost of such care times the number of years until your children are adults. 

Ideally, insurance proceeds should also cover all your debts or provide the income replacement to cover your debt service.  The same can be said for planned education expenses. 

As you build your savings, you can reduce your necessary insurance by the amount of your savings.  For example, based on the above, say you estimate that you need $3 million for income replacement, debt and education and you have $1 million saved.  In this case you would need $2 million in death benefits. 

Small businesses should purchase life insurance policies for key individuals, such as an owner or top employee, to help prevent financial distress if that person were to die.  The death of a key person in a business can throw things into disarray.  Business owners need to calculate the cost of this as well as related buyout expenses, if needed, when estimating insurance death benefits.  It’s the responsibility of all the business owners to monitor and police these insurance needs. 

A life insurance policy has a beneficiary designation by which the policy owner designates who will receive the death benefit if the insured were to die.  This allows life insurance to pass quickly to your heirs, outside of the probate process. 

Life insurance is generally tax-efficient and is not taxable as income to the beneficiary.  However, under certain circumstances you may owe an inheritance tax on life insurance proceeds.  Pennsylvania does not assess an inheritance tax on life insurance proceeds.  For a married couple to have a federally taxable estate their net worth must reach $22,800,000 in 2019 (a threshold that obviously applies to very few families). 

Life insurance policies fall into 2 general categories: term and permanent. A term insurance policy covers a specific period, such as 10 or 20 years.  At the end of that period, you normally stop paying premiums and your coverage ends.  Individuals use term insurance for replacing lost income in the event of premature death.  Term insurance is generally more affordable, and therefore more accessible, for many clients.   

A permanent insurance policy is typically meant to cover you until your death.  People use permanent insurance for wealth transfer, estate planning purposes and business succession. 

Anecdotally, we have seen insurance planning go in unanticipated directions.  For one, we’ve seen several situations where the insured purchased term insurance with the intention of building enough wealth over the term (say twenty years) whereby at expiration, they would no longer need the insurance.  However, too often, the insured doesn’t accumulate the savings they planned and when the term insurance expires, they still need coverage, but they find the coverage unaffordable. 

We’ve also seen people who purchased whole life many years ago and, because of the “forced savings” nature of the premiums, have accumulated a nice cash value nest egg which has become an important part of their net worth. 

All things being equal, in our view, it is best to buy term insurance (because it’s inexpensive) and “invest the rest.”  Too often, though, savers don’t have the discipline to do this. 

Bottom line, insurance is a big part of financial planning.  We not only want to include your insurance information in your financial plan, but we are also willing to objectively review any coverages you have.  We do not sell insurance and have no financial incentive to push you toward any specific insurance product.  If insurance has been on your mind, please give us a call.