How much Life Insurance is enough?
I get asked this question often in my day to day meetings with clients. My answer is a simple one, “what do you expect to change should one of you die prematurely?” Without giving time to answer, I usually follow that up with a variation of the same question, “What do you want to change should one of you die prematurely?” It’s important to approach this “How Much?” question with a discussion geared more toward what is important, rater than the routine answer of averages from people who don’t know us and from lifestyles that we can’t relate to. I try to get my clients thinking more about what they want rather than what national opinion tells them they need.
Let me explain my 2 questions above: What do you expect/want to change?
Some will Want to move closer to family. Some will Want to stop working in order to take care of their children. For others, a nanny may need to be hired, or even a house sold and downsized. Others still will start a career because they can’t afford not to. There are so many variables to what individuals Expect vs. Want to happen as the result of losing a spouse. What you Expect would change doesn’t have to be what you Want to change. You can plan for your wants.
I view insurance as a hired employee. It’s an asset that will be there to work for you, when that loved one no longer is. It’s a generator of income if the proper planning is done. In my opinion, life insurance needs to generate future income, and not just serve as a one-time lump sum payment that covers little more than the current debts of the family. If you don’t Want much of a change (other than the terrible loss of losing a partner) then plan accordingly. I believe that a portfolio should be able to generate a percentage from that portfolio as an income stream. I also believe that it is very important to generate a conservative enough amount as to not require the reduction of principal. What I’m talking about here is a portfolio funded by life insurance proceeds that allows the beneficiary to live comfortably on the interest and not need to take more than that. I typically recommend a distribution rate of 5% or lower from the portfolio. Therefore, when we plan, we take into account the financial need of what all the Wants amount to.
Let’s look at an example… if a husband were to die who made an annual income of $100,000/year, and prior to his death it was both he and his wife’s desire that she not have to work, move/downsize, etc. then we would need enough insurance to replace $100,000 each year indefinitely. Using my 5% rule, it would take a $2,000,000 life insurance policy to generate $100,000/year (5%) in income. The life insurance company would pay out the $2,000,000 policy and the proceeds (tax free) would be invested and allocated in accordance with the annual income needs of the above scenario. Those proceeds could be invested in such a way that aims to generate income indefinitely to the surviving beneficiary.
The time to plan is now, because now you have the opportunity to make proactive decisions rather than reactive ones. Insuring against the unknown allows for you to make the most out of a bad situation by positioning your family according to your Wants vs. exposing them to what they would otherwise be forced to accept.
The opinions voiced in this article are for general purposes only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing.
