The question that is often asked is how much life insurance should I buy. My response is typically none if you don’t care about anyone other than yourself. Rather than focus on the issue of how much life insurance to buy, why wouldn’t we first ask ourselves the question of who do we value the most in our lives and how much do we really care about what happens to them once we are no longer present in their lives? After all, isn’t the true intrinsic value of life insurance for the “insured” the emotional value of knowing those we care about the most will be provided for financially after our death?
The very first step is to identify those who you are wanting to provide for after your demise.
- Spouse
- Children
- Extended family
- Charity
The second step is to gain clarity of what you specifically want to accomplish.
- Pay off debt
- Cash reserves
- Funeral expenses
- Healthcare expenses
- Income replacement
- Child support
- Educational expenses
- Retirement funding
- All the above
The third step is to determine how much time is to be covered. If for example the surviving spouse is in their early thirties and the children are in their beginning years, then you may very likely want to cover a twenty year period of time or longer. Whereas if the surviving spouse is in their mid-fifties and the children are late adolescence, then the time frame will be shortened with the exception of investible assets for retirement.
The fourth step is to evaluate your current financial resources and possible transitions.
- The surviving spouses earned income
- Current short & intermediate cash reserves
- Existing employer provided group life insurance
- Current personal in-force life insurance
- Retirement accounts for the surviving spouse’s retirement
- Additional expenses, such as housing maintenance, child care, relocation expenses, additional spousal educational expenses, automobiles, weddings, and care for a child with a long-term disability.
- Any other special circumstance that is important to you.
The fifth step is to determine if the surviving spouse has the desire, knowledge, experience, skill, and emotional maturity to manage a large sum of investment capital without the concern of being exploited by family, friends, or an unscrupulous financial advisor. If the surviving spouse is unable or lacks the reasonable skill sets necessary to effectively manage the assets in a way that is consistent with the decedent’s desires, then it is recommended that they seek competent legal counsel on the subject of trust planning.
Illustration:
| Immediate Expenses | |
| Mortgage | $100,000 |
| Auto Loans | $33,000 |
| Cash Reserves | $100,000 |
| Funeral Expenses | $7,500 |
| Sub Total | $240,500 |
| Survivorship Income (Net Present Value) | $578,454 |
| Child Support (Net Present Value) | $233,158 |
| College Education (Net Present Value) | |
| Child #1 (currently, age 6) | $82,416 |
| Child #2 (currently, age 4) | $81,325 |
| Child #3 (currently, age 1) | $76,094 |
| Sub Total | $239,835 |
| Total Capital Shortfall | $1,291,947 |
| Less | |
| Current Cash Reserves | ($50,000) |
| Existing Life Insurance | ($250,000) |
| Sub Total | ($300,000) |
| Additional Life Insurance Required * | $991,947 |
The $991,947 * in tax free life insurance proceeds will provide for the following:
- Pay immediate expenses of $240,500
- Provide supplemental annual spousal income of $43,000 for over 17 years
- Provide annual child support payments of $24,000 for over 11 years
- Provide four years of funding to a state college for all three children
And lastly, any effective survivorship income plan will be completely dependent on how the assets are invested.The assumptions used should be conservative in nature and the investments should be well diversified. The assumptions used for the illustration, listed above, was based on a realized 6% annual rate of return, 3% annual inflation rate, and the annual distributions were taken monthly at the end of each month.
