Seeking Life Insurance? Stick with Term
Greg Palacorolla, CFP®
Planning for your death or that of a loved one is a difficult task for most. However, it is essential to have those tough conversations with your advisor to ensure that your family is taken care of in case of catastrophe. The most effective way to protect your family and finances should tragedy strike is through the use of life insurance. There are a plethora of insurance products available – some with cash accumulation; others may have an investment component. Due to the variety of options and the complexity that each may present, life insurance can be an overwhelming and complex decision for many people. However, if you are truly trying to plan for the uncertain, safeguard your family’s wealth, and provide for your heirs, there is only one form of insurance needed. And that’s term life insurance.
What Is Term Life Insurance
Term insurance is the purest form of life insurance as its sole purpose to insure against the loss of life. Term policies have a predetermined and fixed duration, coverage amount, and premium. At the end of the term, the coverage lapses and no additional premiums are due. If the insured dies within the stated time frame, the designated beneficiary(s) will receive a lump sum payment for the face amount of the policy. Proceeds from term life insurance claims are tax-free to the beneficiaries. Because of its simplicity, term insurance is by far the cheapest form of coverage to obtain.
Considerations When Obtaining Term Coverage
The common questions when determining your life insurance needs are: How much do I need? How long do I need it?
In order to answer these two questions, you should consider three main factors. The first consideration is how much debt your family has. Mortgage, student loans, auto loans, and credit card debt should all be factored in. Insurance should cover most, if not all, of your outstanding debt liabilities. A major burden for your heirs is servicing your debt obligations, so having insurance in place to pay off those liabilities at your death is paramount.
The second major item to factor in when calculating your insurance needs is the college education expense for all of your children. College has become a necessity, while simultaneously becoming insanely expensive. It is an essential expense that many parents plan to cover in full for their children. If that’s the case, insurance proceeds can be used to fund this significant expense.
Lastly, life insurance should be purchased to provide income replacement for your family and dependents. While insuring against the potential loss of 20-25 years of income would be great, that summation of those earnings would be very expensive to insure. Therefore, targeting 2-3 years of your current salary is a good starting point. Since all proceeds are income tax-free, 2-3 years of life insurance proceeds is the equivalent of 4-5 years of after-tax income that the insured would have been earning.
Once you determine your insurance needs, it is important to make sure you have coverage for a sufficient amount of time. A few general guidelines for determining the length of your coverage:
- Age of children – ideally, insurance is in place until they have graduated college and are completely independent financially.
- Mortgage Maturity – having insurance in place until most/all of the mortgage is paid off is crucial. Once the mortgage burden is removed from the equation, your need for insurance decreases
- Retirement Age – Estimate a target retirement date and insure your life until then. Once you retire, income replacement is no longer necessary.
For many clients, these three considerations last until age 60-65. Term life insurance is available for various time periods (10, 15, 20, 25, or 30 years), so you can cater your policy to your specific financial situation.
How Geier Asset Management Assists in the Life Insurance Process
Life insurance is a significant component of the financial planning process. While there are numerous types of insurance, we feel that term insurance is the most cost effective and purest way to insure against an unforeseen tragedy. We typically avoid the permanent insurance products because it’s much more expensive and we believe that the need for insurance terminates at a certain point in your life. We prefer investing the annual premium savings of term insurance into your retirement portfolio.
For new clients, we’ll conduct a thorough insurance analysis to determine the need of each specific client. We are able to shop your case to all of the insurance carriers to find the most competitive premium. Once the insurance is in place, an annual insurance review is conducted to ensure your life insurance covers all of the considerations listed above. As life changes, the simplicity of term insurance allows your coverage to change as needed.
At Geier Asset Management, we prefer to keep your finances as simple as possible. So, when you are determining which life insurance product fits you best, just keep it simple and stick with term.
© Geier Asset Management, Inc. June 2016. Greg Palacorolla is the Director of Wealth Management for Geier Asset Management, Inc., a Registered Investment Advisor. The above blog reflects the opinions of Mr. Palacorolla and not necessarily the firm. Any advice given is general in nature and investors must consider their own individual circumstances. Past performance is no indicator of future performance. The firm makes no warranties or representations of any kind relating to the accuracy or timeliness of the information provided.