Buy the Right Amount of Life Insurance
“He who knows that enough is enough will always have enough.” —Lao Tzu
How much life insurance is enough? There is no “right” answer to this life insurance question because everyone and every situation are different. Nevertheless, there are wrong turns and deep potholes you should be aware of.
Watch out for the following insurance planning hazards:
It is possible to go broke buying insurance. It is impossible to insure against everything. The most important risk to insure against is the burdens that will fall on others when the insured person not here.
Term life insurance can meet most life insurance needs with the exception of estate liquidity issues and estate tax requirements. Do not spend extra on whole life, UL, VUL policies to receive the same amount of coverage that you can buy for less with term life.
Employer-provided life insurance does not count in insurance planning. It is a great benefit, but if the job is left voluntarily or otherwise, then there is no life insurance.
One year while reviewing a tax client’s prior year W-2 forms, I noted that he had lots of insurance bought under his employer’s group life insurance plan. After explaining the potential hazard, I recommended that he also take out life insurance policies outside those provided by the employer. The next year I asked the client again about obtaining insurance outside of the employer’s policy. He replied that he wished he had taken the suggestion. The client had been diagnosed with cancer, and while he was expected to recover, he feared that if he were ever laid off, he would not be able to purchase life insurance at any reasonable price because of the cancer.
Purchase life insurance only from top-rated companies. Ask the insurance agent for the rating on the insurance company. Then, look up the AM Best rating for the proposed insurance company. It is important that an insurance company will be there for the life of the policy.
Premiums will vary even across the top-rated companies, so it is worth shopping around. Be aware, however, that cheap life insurance sold via the Internet might not be so cheap years from now when it is needed if the cheap insurance company is no longer there or endlessly contests a straightforward claim to avoid payment.
While most of the financial risk seems to be related to the perceived breadwinner in the family, insurance should also be bought on the spouse, particularly if there are children involved. The breadwinner and spouse function as a team, and if part of the team is missing, the financial burden will generally increase not decrease while the children are still living at home.
Estate liquidity issues are often overlooked. Fortunately, when my parents passed away, they each had a relatively small whole life policy, which provided immediate liquidity to their respective estates for legal, funeral, and other costs. In settling the respective estates, I was grateful that I did not have to immediately sell estate assets (stocks and bonds) to raise cash.
Although immediate estate liquidity is rarely mentioned by insurance agents or taught in the financial planning courses, having to sell something on short notice exacerbates an already stressful transition for the executor of your estate and your heirs. Purchasing a small whole life or UL policy early in life is a great help to them, and doing so when you are young is important because later in life, term insurance will become too expensive.
In general, for a given amount of coverage, the younger the insured person, the lower the life insurance premiums will be. So, putting off insurance planning until you are older not only exposes your estate (and loved ones) to greater financial risk, but it makes obtaining insurance coverage more expensive.
Scott Anderson, CPA, CFP®, EA is the CFO and Vice President of Tax Strategies for GW Financial, Inc. He earned his MBA from Stanford University. Scott has spent over 35 years in corporate accounting and finance, including experience with several entrepreneurial opportunities in venture capital startups and corporate turnaround situations. He has served as Chief Financial Officer for two emerging public companies and has his own active practice in tax, financial, and investment planning for individuals and small business owners.