Want to clear up 2 things I’m sure you’re thinking. First, I’m not a life insurance agent anymore. I stand with zero interest here in what company you use or whether you think insurance is a good investment. Secondly, I know you’d rather talk about investments. That’s the fun part of the financial rehab plan. However, just like rehabbing a home, the quality of the outcome is determined by the preparation.
You really can’t talk about finance and family without talking about insurance. Let’s tackle it head-on. Here’s the truth, insurance costs money, it’s frankly your responsibility if you have a family, therefore it’s part of your budget.
Just like budgeting for your emergency fund, there are levels or stages of insurance. There’s not a one size fits all solution, instead, there are strategies to use insurance depending on where you are.
Term insurance’s main purpose is to replace the income of an income earner in the family. For entrepreneurs that die earlier than they expected, this can often be even more devastating because it could mean the end of a business. If you’re just starting out or starting this financial rehab journey, then term insurance is where you start. It could also be all that’s needed.
Term insurance is the cheapest insurance there is. Less than 1% of all term policies payout. Either people are living longer or they let their insurance lapse. Either way, if I am going to die sooner than I thought I would then I’d rather be in the 1%. It’s the minimum you can do for your family.
How Much Term Insurance Do You Need?
Online you might get advice on getting 5 or 10 times your earnings or look at getting enough coverage to wipe out your debt. While that’s a good approach I’d suggest a slightly different strategy. If you’ve been reading our Financial Rehab series, then you’ll have a budget already. Consider who you’d be leaving behind if you were to leave Earth a bit early.
- Provision for your spouse
- Provision for your children
- Pay off mortgage
- Pay off other debt
- Living Expenses for ___ Years
- Business Debt
- Other considerations (Would you like to donate to charity? Would you like to pay off a parent’s or child’s debt?)
First consider your spouse, if you’re married. Do you want them to work, be able to take time off, etc. Luckily you already know your budget so you can do the math here. Secondly, do you want your family to continue to live in the situation they have or pay off the debt. Another consideration is if you have children, would you want to fund their education. Finally, what about a legacy? Is there a cause that you would want to designate funds to in the event of your untimely exit? Also, the proceeds from a life insurance policy are tax-free.
Devon’s “budget account” needs 6 months of expenses which we have calculated to be $60,000. To operate his household takes $120,000 a year to allow for the times the family goes out to eat pay their mortgage and overall “ceiling” finances. He’d like his wife to have 5 years off from working which would give her enough time to get a degree or downsize if needed but takes the edge off. When you add it up, he’s already at $600,000 policy. He wants her to have the option of paying off the mortgage, which is at $250,000 and they have 2 children and he’s going to want $50,000 a piece to help with college. If you add all of that up, his total policy is $950,000. Whether Devon takes a $1.2 million (10 times earnings) policy or $950,000 policy you can see that he’s covered.
Because Term Insurance is inexpensive you could easily have a million-dollar policy on top of whatever other protection pieces you have in place. Because its term, we are not overly analytical about our strategy. There’s a 99% chance that you won’t use this policy at all.
How Long Should My Life Insurance Coverage Last?
Because the purpose of term insurance is to replace income, we can answer this pretty simply by answering the question, “how long will I earn income?” If you plan to retire at 65 and you are currently 30, then you’ll want a 35-year policy. The chances are pretty good that you may want to buy more insurance as your income increases. However, you may want to rethink cancelling the policy even if your income increases. Remember the proceeds are tax-free and the insurance is cheaper the younger you are
Any talk about insurance is not complete without covering a few more bases.
Term Insurance Offered Through Mortgage Companies AKA “Credit Life”
Stay away. Period. The insurance offered by mortgage companies, credit card companies otherwise known as “credit life” are not only overpriced garbage but does nothing to protect your actual family. It pays off the debt you owe which I suppose is a benefit but the beneficiary is actually them and not you. It’s far cheaper to fund this yourself.
Child Term Insurance
If you’re saving then there’s very little reason to have term insurance on your children. You can actually add child term riders on many policies for pennies on the dollar if you want a final expense (funeral) costs covered. There’s simply no reason to do this.
How to Choose An Insurance Company
Before I go into more advanced insurance concepts, let’s look at how to select a good insurance company.
There are multiple companies that rate insurance companies. They primarily are rating their financial strength and not necessarily any consumer factors such as customer service or ease of pay-outs. Two of the most common are AM Best and Standard and Poor’s rating.
AM Best ratings are fairly straightforward descriptions. For example, top-rated companies receive the rating of Superior – minimal risk of financial instability, most able to meet claim obligations. Typically companies with “Superior,” “Excellent,” and “Good” are safe. While “Adequate” and anything below “Below Average” should best be avoided.
In Standard and Poor’s ratings as well as many other rating system they use an A, B, C grading system. Typically in these rating systems, you would not want a company that is below an A as the A goes from A to triple A+.
This is a must-have feature. Unfortunately, the life insurance industry has not made this an easy distinction. There’s a very popular company with great advertising that calls their “whole life” policies ‘living benefits” but this not what we are talking about. There are A-rated companies out there that sell term and other insurance products with a Living Benefits Rider.
While only 1% of life insurance policies are ever paid, we have a 70% chance of having a heart attack, stroke, cancer or some other illness that takes us out of the game. While long term disability insurance is also an answer, what we are recommending is that you examine your current policy or go shopping for one that has the living benefits rider.
Living benefits riders allow the insured to access some benefit in case of a major medical situation. Each policy is different. One company, National Life Group (rated “Excellent” and “A” by both AM Best and Standard and Poor) has this posted.
Pays a benefit if you are diagnosed with a terminal illness resulting in life expectancy of less than 12 months (24 months in some states). This can be used for experimental medicine, prepare for final expenses or any other purpose you feel necessary.
Pays a monthly benefit should you become diagnosed as chronically ill and unable to perform two daily activities such as bathing, dressing, eating, or due to cognitive impairment. This benefit is paid annually (up to 24% of your death benefit). The policy must be in-force for 2 years.
Pays a lump sum benefit should you suffer from a triggering illness such as cancer, heart attack, stroke, Lou Gehrig’s disease (ALS), blindness due to diabetes, kidney failure or major organ transplant, and more!
The reason this kind of protection is needed is that often families are hit with problems that become exponential. Not only do families in this situation have an increased health care cost for their overall budget, but they also have in many cases, a loss of income.
To get more details you should contact a professional. My recommendation is an actual financial planner. Many financial planners have insurance licenses and can help with this. Be wary of insurance agents that pretend to be financial planners. Interview and ask for questions upfront. Do all of the “planner’s” suggestions relate back to an insurance product or do they have other expertise to help you with your total map, instead of this road stop?
Permanent insurance is for those financial rehabbers that are doing so well financially that their children wouldn’t qualify for financial aid in college. Permanent insurances (whole & universal) are highly strategic. It’s a strategy for someone that wants more insurance and plans to use it as a tax-free source of money. This strategy works because you aren’t taxed on loans. Essentially you’re giving money away now so you can borrow it from someone later and when you move on, you’re debt (the loan) and what you paid (plus interest, minus the cost of the insurance) is returned to you. I call it permanent insurance because if you aren’t all in (for the duration) you most likely wasted your money.
There are two types of permanent insurance that we will cover. Whole life and Universal. Both take your premium use it to buy the insurance and “save” some for you. The promise is that this money will grow over time and that you can access this money at a later date tax-free.
I strongly advise that you seek professional advice when it comes to selecting all insurance. In some cases, the cash value will not go to the beneficiary and in other cases, it will. In addition, there are options like Living Benefits and annuitization of payments that might be desired when setting these policies up. Finally, a good planner that understands insurance can even design a specific plan to suit your needs. It’s my belief that a planner that understands insurance but doesn’t sell insurance as their “main thing” can give you proper advice on this.