17 September 2013 0 Comments

A Set Of Non-Emotional Principles For Purchasing Life Insurance

consider carefullyHere’s a question I was recently asked:

What is a (non-emotional) set of principles for life insurance purchases that represent the best use of money and best balance of low cost, disaster versus investment choices as you age?

Here was my answer:

In a typical family setting, the first principle is to realize that the major function of life insurance is to produce cash at death sufficient to cover final expenses and replace future income potential of the deceased.  In the case of a non-working spouse, the cost of  home-maker and child care should be treated just like the replacement of future income potential.

If the person considering life insurance (click here) has health insurance sufficient to cover last medical expenses and enough cash to cover funeral costs, it could be argued that life insurance is not necessary to cover final expenses.  The need to replace future income potential depends on whether or not any other person is dependent, or could become dependent, on the income of the insured.  If there is absolutely no one in the life of the insured who is, or could become, dependent on that person’s income, then life insurance is unnecessary.

If there are survivors who depend on the income of the insured, the duration of income  need  declines with age.  At the same time, income normally increases with time and inflation will require more dollars in the future for the dependents.  Determining the correct amount of life insurance needed today to replace this changing income pattern is difficult.  But, taking into account the investment income potential of a lump sum of life insurance and the Social Security monthly   dependent survivor benefit, 10 X current annual income is a reasonable amount of insurance to carry.

During the early family years, until the insured attains age 55, term insurance should be purchased with a 20 or 30 year duration.  As the insured ages, builds other assets and children reach maturity, the life insurance can be reduced to reflect changing needs.  From age 55+ one should determine for how long they want to continue insurance and for durations that exceed age 75 they should replace the term with Universal Life with long term guarantees.  Otherwise the cost of term will become prohibitive.  Depending on their health at that time, they might want to convert some of the term they currently own.

Only after the maximum death benefit required has been covered with term insurance should life insurance be considered for an investment choice, and then it should never be considered for short term liquidity.  The best use of life insurance cash values is for retirement income.  Because of its tax deferred build up and tax free disbursement of funds through withdrawals to basis followed by no-cost policy loans, life insurance can look very attractive as a retirement income supplement—especially today’s Indexed Universal Life policies.  Minimize the death benefit in these policies to enhance the investment features.  Don’t plan on this as a viable method unless you have about 15+ years until retirement.

Finally, a word about your request for a “non-emotional set of principles” .  I’ve attempted to follow your request.  However, if life insurance buyers did not buy as a result of emotions, there would be far fewer families protected by this product.  When you are dead there is nothing that you will personally gain from having purchased life insurance.  Buying protection for your family must be motivated by the love you have for those who will be here after you are gone.  If you didn’t care, spend that life insurance premium on items that will bring you current comfort and happiness.  Emotions are a part of the life insurance purchasing process…and that’s a good thing.

Next…trying to manage life insurance proceeds after you die.

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