By Justin Haschke, CPA/PFS, CFP®
Who among us doesn’t think the life decisions we made a decade or two ago are due for a review? Just as you might be rethinking your wardrobe choices or music tastes from back then, it’s also important to take a second look at your life insurance.
Life insurance isn’t a one and done transaction. The financial needs you had at say age 30, when you were newly married, renting an apartment, and just launching your career, are probably quite different today. Now you might be a parent, own your own home, and have several promotions and raises under your belt or have started your own business. As your life gets fuller and more complicated, you need a different approach to life insurance. And when your children are grown, your working years behind you and you’re in downsizing mode, life insurance merits a review then too.
That’s why we urge all our clients to periodically examine their life insurance to make sure it’s keeping up with their lives.
Why do I need life insurance?
As unpleasant as it is to think about, the primary purpose of life insurance is to protect your loved ones from financial hardship in the event of your death. True, life insurance products come in various forms and they can be used for a number of purposes. But at its most basic, life insurance must provide financial protection for your loved ones. Rather than stressing about money, your family should have the financial freedom to deal with their grief and moving forward.
Think of life insurance as a risk management strategy. For a young family, life insurance is crucial to provide income replacement for the surviving spouse to take of themselves and their children. With the right amount of life insurance, the surviving spouse can continue providing the same lifestyle to the surviving children as before and stay on track for retirement.
For an entrepreneur, life insurance can help to ensure the continuity of their business. After all, there might be 20 or 30 families that rely on that business for their livelihoods.
For the price, life insurance is a pretty inexpensive risk management tool. The earlier you purchase it, the more affordable it will be, and you can lock in those rates for as long as the policy stays in place.
Term life insurance is the most cost-effective way to purchase life insurance and it’s the best option for most people. For example, the average cost of a 20-year policy with a $500,000 death benefit costs a nonsmoking 25-year old $372 a year. However, a 40-year old can expect to pay $600 a year.
How much life insurance do I need?
Figuring out how much life insurance you need depends on several factors, including how much you make as well as what your financial obligations are. A simple rule of thumb is to buy a policy that’s pays a death benefit of between seven and 10 times your annual income. Therefore, if you make $80,000 a year, you might consider a life insurance policy with a death benefit of $560,000 to $800,000.
But remember, that’s just a rule of thumb. For many people, those amounts are not enough. A life insurance policy needs to be large enough to replace your earnings for as long as your family would rely on that income. In addition to how much you make, there are some other considerations that go into deciding how big of a policy to buy, including:
- Size of mortgage
- A special needs child
- Estate tax
Finally, be sure not to overlook the financial contributions of stay-at-home parents. Although stay-at-home parents don’t bring home a paycheck, there is economic value to the labor they perform. In fact, Salary.com estimates the market value of stay-at-home moms’ labor at $184,820 a year for tasks like childcare, cooking, driving, and homework tutor. Would you be able to afford to hire others to perform all that work?
When should I review my life insurance?
We recommend revisiting your life insurance needs every three or five years as part of a comprehensive financial planning process. However, that doesn’t mean you shouldn’t make changes outside that window if you’ve experienced a significant life change. Some common reasons to consider making changes to your life insurance might could include:
- Starting a business
Recently, I met with two clients, a husband and wife in their late 40s and early 50s. Their situation was typical of what I’ve seen many times. The husband, a plant manager at a local manufacturer and primary breadwinner, and wife, a stay-at-home spouse who home schooled their children, had purchased their life insurance through the husband’s job. Our analysis showed that that policy wasn’t large enough. We recommended that the couple purchase an additional 10-year term policy, which should last long enough for their children to reach adulthood.
By the same token, there might be times when a review suggests that you can cut back on life insurance.
That’s what happened with one of our clients, a couple in their 30s who was paying $1500 a month for a permanent life insurance they had had in place for the previous 10 years. We thought the policy was overkill for their needs, which was simply to provide for their children, ages 12 and 10, in the event of their untimely deaths.
Instead, we recommended 10-year term life insurance that would cost them $1200 less per month. We then suggested that they take the cash value the permanent insurance had accumulated over the past 10 years and seed two 529 college savings plans. Finally, we recommended that they use their monthly savings to add to the 529s. The result: the family has ample life insurance and they were able to free up cash flow in their monthly budget to save for college for their children. Those accounts should be fully funded by the time their kids are ready for college.
Life insurance for estate planning
Again, I can’t stress enough that the primary purpose of life insurance is to provide economic protection in the event of an untimely death. But there are times when life insurance can also serve other purposes and can give your financial plan some flexibility.
One of those reasons is estate tax.
We recently met with a couple who had a taxable estate of $20 million. Their children were grown and they no longer had life insurance. When we reviewed their finances, we realized that they were in need of estate planning given this sizable estate. And because the bulk of the estate was tied up in their farm, the heirs would likely face difficulty coming up with the money to pay the estate tax.
We recommended that the family get permanent life insurance to help cover the potential tax liability. While permanent life insurance can be pricey, it made sense in this case. First, since we have no idea about the timing of their deaths, this couple needs a policy that will last as long as they live. In addition, even if the life insurance costs them $500,000 for a $5 million policy, its money well spent. That’s still less than the estate tax they are likely to owe and will give the family liquidity when they need it most.
You know the saying: The only thing you can count on is change. Since life is constantly changing, your life insurance should too.
Plan to revisit your life insurance needs at least once every three to five years—if not more often—and make changes that reflect your current reality. There might be times when you don’t have enough insurance and you could benefit from additional coverage. Or you might reach a point when your life insurance needs are minimal, and it’s time to dial down the coverage. As your life circumstances change, make sure your life insurance is keeping up.
This piece is not intended to provide specific legal, tax, or other professional advice. For a comprehensive review of your personal situation, always consult with a tax or legal advisor.