Jul 16, 201510:23 AMFinancial Perspectives
with Michael Dubis, CFP
Life insurance rules of thumb usually don’t apply to real life
(page 1 of 2)
In my experience, many folks do not have adequate life insurance. Most insurance rules of thumb that calculate needs don’t do a good enough job of pricing on this one.
Let’s face it: insurance is boring, but complex; requires you think about your mortality; requires you to also think about an estate plan; and is ultimately something you actually should hope to pay for throughout your contract term but never actually need to use. In other words, you want it to be a complete waste of money, even though it ultimately costs a lot.
It’s understandable that most folks don’t want to think critically about life insurance. But thinking critically is a responsibility you bear if someone else’s quality of life depends on having adequate life insurance if you’re not here.
In a nutshell, life insurance seems to boils down to answering the following questions:
- If you are no longer here, will someone else suffer financially as a result of your death?
- If so, for how long?
- And for how much?
- Finally, do you care and are you able to do something about?
If you answered yes to the above, you need to calculate the needs. Rules of thumb to obtain insurance are often inadequate. Here are two examples where “rules of thumb” are usually harmful.
- “Ten (or X number) times your salary should cover need.” This is something that I’ve heard or read a number of times over the years. It’s usually bad advice for a young couple with kids who might have 20 to 40 years of work ahead of them. Further, it’s bad advice for an older couple approaching retirement who have no estate tax issues and are already close to financial independence and may actually have little need for insurance.
This is only good advice when X times your salary works actually answers the questions above. In all the calculations I have ever done, for example, I’ve never seen 10 times your salary be the answer.
- “Buy term and invest the rest.” Another poorly executed broad-stroke piece of advice. Let me be the first to criticize fee-only advisors (like me) who are often guilty of this broad-stroke advice. Shame on us if we don’t back that generic comment with good hard analysis. For example, this is likely bad advice for:
- Someone who might need a lifetime to achieve financial independence. Think younger, high-income folks who also have a lot of debt and might need 30 to 40 years to achieve that independence. A 10 to 20 year term policy simply won’t cut it!
- Someone who is going to face a possible estate tax problem either in the form of liquidity or tax offset, or both, and wants to have liquid funds available to address those goals. Small business owners or large estates may face this scenario. One should see a qualified estate planning attorney for this advice and then get plan design and calculations done by a qualified advisor.
- Someone who has a child with special needs. A family with a special needs child may need to care financially for that child in rather expensive care facilities for multiple decades if they are no longer here. You may also have federal and state resources outside of the scope of this article that need to be expertly planned for and which no financial planner or insurance agent is completely qualified to do for you since it constitutes legal advice. You should first and foremost seek out a qualified special needs planning attorney, then bring in a qualified advisor.
In all of these cases, the idea of buying some arbitrary level of term insurance or using X times salary is dangerous unless you can be absolutely certain the term will match a plan design 10, 20, or 30 years from now.