Life Insurance: The One Financial Conversation Even Professionals Get Wrong

The Taboo discussion of "Life Insurance" may be one of the most misunderstood financial topics right now. My goal in this post is to help you understand what life insurance is, when would you need life insurance, and the common misconceptions to avoid.

A little about me... I'm engaged to my lovely fiancée, no kids, and don't own a home (I rent). But what may be surprising to most is that I am currently applying for Life Insurance now even before most would think I need it. Additionally, my wealth management team assists with many applications a year for Life Insurance and throughout I see one common need for it.

"I don't want to worry"

It's as simple as that. That will be your primary reason for getting Life Insurance and any insurance in general. Not to be some fear-monger but I want to give you an idea of some worries related to Life Insurance, here's a list:

• "My spouse relies on my income and If I were to pass away today, their life would drastically change from a financial perspective"

• "If I were to pass, I would hate to have the burden of debt over my family"

• "I want my kids to go to college and if my family were to no longer have my income there would be no savings for this goal"

• "My elderly parents rely on me to take care of them and if I were to pass away it would put that burden on my spouse and kids. I just want to make sure my parents get the care they deserve if I were gone"

• "I have a special needs kid and if both of us (the parents) were gone, we want them to be financially set up to have the best care for the rest of their life"

• "If my spouse who stays at home with kids were to pass away, I would have to hire a nanny to fill their role, and it would cost me $X dollars per year. Work is busy and I don't think I have the capacity to fufill that myself."

These are just a few worries that would trigger the need for money to be provided to your family in the event you had a pre-mature death.

First, what really is Life Insurance?

Life Insurance is a contract between you and a financial institution (Insurance carrier), outlining a trade of risk through the payment of premium.

More simply put... you pay the carrier a premium and in return they pay out a large benefit in the event of your demise. For example, a male 25-year-old in great health looking for $1.0m in coverage for 20 years, you can expect to be paying roughly $28 dollars per month. This means after one month of a $28 payment and you pass away, the insurance carrier would pay your beneficiaries $1,000,000. In almost all cases, this payout is completely tax-free, and your beneficiary can use it to pay off debt or fund their lifestyle (or whatever else they'd like).

Sounds like a bad bet for the insurance carrier, right? Well not exactly. Research shows that term policies like the above payout roughly 2% of the time (Is Your Term Life Insurance a Waste of Money?). So why would I pay for something that seems to be a bad investment?

This is where most people get it wrong. Life Insurance is not an investment. It's a risk management tool that helps you worry less through the payment of premium to a carrier. If your life insurance never pays out that's more than likely a good thing. That means you were lucky enough to live past the term you originally outlined with the insurance carrier.

If you've made it this far, odds are you have realized that you either need life insurance now, or sometime in the future. I highly encourage you to reach out to our team via my contact page and we can help determine what's your best fit. For most, they just want to sleep easier knowing that their family is covered with cheap payment of premium.

CONTACT | Chace Cooper

How do I determine my Life Insurance Coverage?

My first suggestion is to not be cheap and say, "My family is going to be okay without me, and I'll probably outlive the coverage anyways". For the ultra-wealthy, this may be the case. But for most, this is the selfish/lazy thing to say and if you are serious about taking care of your family, you will see past this thought process.

Next, your coverage amount can be entirely dependent on your specific situation but here are my rule of thumbs:

• Determine how long you would like to have coverage. For younger families (20-40), this typically means you are looking for 20 to 30 years in coverage. This will get you just far enough to build liquid assets that can replace the purpose of term life insurance.
  

• Next, tally up your total debt that would be liable to your surviving spouse. Here's some examples:

  • Joint car loans

  • Joint mortgages

  • Joint credit cards

  • Private and co-signed student loans

  • Medical debt depending on the state

  I'd recommend making a goal to have my coverage cover a portion if not all of the outstanding debt that your family would be liable to pay in the event you were to pass.
  

• Possibly the most important factor is covering your income. This is especially so if your spouse does not work and supports your family's lifestyle at home. You passing away can drastically affect their life resulting in them most likely going back to work if no coverage is set in place. So how do I determine how much coverage I should have to protect my income? There're two thought processes with one being drastically easier than the other.
  

  • Simple Determination: Determine your "life value" in income. Let's say you plan to work to 65 and you're currently 45. You have 20 years left of income to cover before retirement that if you were to pass away today, your spouse would no longer have. Simple math says to take the 20 years and multiply it by your income amount today. For example, with $100k in income that would mean $2,000,000 in coverage would cover your life value.
    

  • 4% Rule: Line up your expenses and determine how much a year your family needs to live. For example, let's say its $100k a year. Here's how you would calculate the amount of coverage needed using the 4% rule:

    • While widely debated, wealth management gurus suggest that taking 4% out of your portfolio a year is a safe amount of withdrawal to have no issues for the rest of your life. Once again widely debated and entirely personal to your situation. But we will use that thought process here.

    • Take your expenses ($100k) and divide it by 4% (.04). This results in your family needing $2,500,000 in total coverage to comfortably withdrawal $100k a year.

    • An additional way to calculate is to take out the expenses that would no longer be there if you were to pass away. This may drop our example expense amount from $100k to $80k. This would result in $2,000,000 in total coverage instead.

      
      

  • Lastly, factoring in the amount of liquid assets you currently have could reduce the coverage amount you obtain. For example, if your bank account had $1.0m in it, you will take your determined insurance amount and reduce it by $1.0m. I would also keep in mind factoring in the after-tax amount of assets is important. Remember, accounts such as Traditional IRAs or 401ks show you the total you have before you pay taxes.

Chace, why are you getting insurance without any of the needs listed above?

Nothing in life is guaranteed and I prefer paying the price now, to lock in my health at a cheap rate. While my family may not have an immediate need for my life insurance coverage, one day they will and I don't want to make the decision too late. Remember, the insurance carrier is going into a contract with you regarding risk. And if you are unhealthy and seen as riskier, they will charge you more or potentially never offer you coverage. This is like trying to get insurance on your home that sits in the middle of a volcano.

I want to guarantee a few things:

• A cheap rate at a young age

• A good health approval from the carrier (1 to 15 health approvals that affect your premium)

• Lock in coverage now while healthy that way down the road, when I truly need the coverage, it will be there. I don't want it to pay out but God forbid it does, I made the right decision.

Our team has come across many individuals that have waited until it is too late to seek coverage and were unable to attain it. I can tell you with full experience that it is not a good feeling and an easy one to avoid.

Final Thoughts/Misconceptions

The life insurance industry is infected with many salesman that will put you into products that you never needed. Our team has come across countless new clients showing old policies that never benefited them in the first place. Unfortunately, this is the reality of the industry and all I can do is try to help educate you on making the best decision for yourself and not the salesman.

One topic that comes up a lot is Term vs. Whole Life. I may make a post in the future on how to determine which one you need and what use cases whole life would have in your situation. If this is something you're interested in, let me know and I can make a post outlining the differences, and pros/cons.

One thing I hear consistently:

"But if I never paid $X a month in premium and invested it instead, I would have $X in 20 years". Completely understand the sentiment. But once again, it is not an investment. It is a trade of risk, and it's designed to help you sleep at night.

More than likely the premium you will pay for term life insurance will be so small it will not change your lifestyle. Additionally, if you have a shortage of savings in the future, paying the premium on your life insurance was most likely the least of your problems.

Lastly, for most individuals, you should have access to employer provided life insurance. I highly recommend starting here as it will be the cheapest form of coverage you can obtain. The only catch is that it typically only covers 1 to 2 years of your salary which as we discussed above, is likely too small. Additionally, if you were to leave the company, you lose the coverage. Start there first then venture the private coverage route.

Our team has helped countless individuals determine when life insurance is a good fit in their lives. If you are interested, or currently have coverage and want a second opinion, reach out and I'd be happy to direct you to help you enjoy more and worry less.

CONTACT | Chace Cooper