Young adults
starting out in life, especially newlyweds, need insurance. But what kind? As a
start, a good term life policy likely is a smart move. Other types of insurance
may not be. And as they age, what other varieties of coverage make sense? A
good deal of misunderstanding surrounds insurance protection planning.
Consider a couple,
basking in the glow of their recent and beautiful wedding. For them, death is
an abstraction that seems a remote possibility. But a life insurance agent, a
friend of the groom, suggests that as a newly married man he consider life
insurance – namely a $200,000 whole life policy. Here’s why that is probably an
unwise strategy.
Two Basic Forms of Life Insurance
Term insurance is
pure mortality coverage, paying off if the insured dies within a specified
term, usually 10 to 30 years. It has no cash value element, where extra premium
is invested and functions as a savings account for the policyholder.
Then there is
mortality insurance combined with a cash value element, often referred to by
agents as permanent insurance and which may be in force for life. This type of
coverage comes in various forms. With whole life, the insurer pays an annual
dividend, based on at least a guaranteed minimum amount to build cash values.
With universal life, the insurer pays interest at least a minimum guaranteed
amount.
Variable universal
life builds value based on a basket of separate accounts similar to mutual
funds while offering premium flexibility. Obviously, if a policy combines cash
value with a death benefit, premiums generally are higher– and considerably
higher at younger policyholder ages – than one would see on a pure-term life
policy.
Different types of
contracts have uses relative to estate and charitable giving objectives, so one
cannot make a blanket statement as to what kind of contract is best. For our
newlyweds, 30-year term insurance might be the preferred solution.
Think About What Insurance Does
The primary purpose
of life insurance is to protect someone from the economic implications of your
death. Of our couple, both worked. What if he died and she was pregnant, or
they already had one or more children? As a widow, perhaps with children, what
would the loss of his salary mean to her economic security?
Conversely, if she
died and he had to raise children alone, what would the loss of her income mean
to the family? A sum of $200,000 invested at 4% net of taxes produces $8,000
annually, $667 in monthly income. Is that enough? Hardly.
Suppose he or she
made $100,000 yearly. At 4%, you need $2.5 million in face amount to generate
$100,000 per year. For each $10,000 of annual income replacement needed, at 4%
a face amount of $250,000 is required.
In the effort to
sell whole life or other types of cash-value-building life policies, agents
might suggest assembling a life insurance estate over time. That’s fine if you
live long enough. But what if a breadwinner dies too soon?
One criticism of
term insurance is that it is cheaper because people outlive it and never
collect it. True. But if you live to age 65, for example, and diligently invest,
building cash value and financial independence in retirement plans and other
investments, what’s wrong with that?
If you want
insurance to continue past 65 or so, a contract that pays off no matter when
you die is a valuable part of estate planning. That’s what some variation of
cash-value-building insurance is for. What if most of your estate is a large
non-liquid asset, such as a farm or closely held business? That means you or
your heirs can’t turn it into cash quickly.
Upon your death, an
insurance payout meets that need. You may wish to provide for estate liquidity
using second-to-die insurance (covering a couple, with the benefit awarded only
after the surviving partner dies), also known as the last survivor life. These are
efficient vehicles for trust funds, especially special needs trusts for
impaired children or adults, to provide for charitable gifts, or to pay estate
taxes.
What about
accidental death and dismemberment policies? Every time a major plane crash
occurs, people think about such coverage. But of the 2.4 million deaths in the
U.S., only 120,859, or 4.9%, resulted from accidents of all types. AD&D is
cheap because of the low odds of dying from an unintentional injury. Do not use
AD&D to cover basic life insurance needs.
Insurance Should Be Part of Your Plan
In holistic
financial planning, look at all needs for insurance. Do you carry umbrella
liability coverage on your car, boat, private aircraft or home? This protects
you from aggressive lawsuits if someone is injured while aboard or inside one
of your possessions. Many people miss that one.
As a breadwinner,
do you have disability insurance from your employer? If so, and you are a
higher earner, you may need to supplement a work policy with personal
disability coverage. If you are self-employed, is disability covered?
If you are an
entrepreneur with partners, are buy-sell agreements funded and insured? With
these pacts, you commit to letting your business partners buy out your interest
upon your death. The insurance on your life allows them to afford it.
As you get into
your fifties, consider long-term care coverage. This covers you when you can’t
take care of yourself, and need a caregiver to come to your home or you must
live in a nursing home.
Newlyweds in a
state of bliss often are confounded by “what if” questions. At the altar, they
made pledges to each other.
Regarding financial
security, across-the-board insurance planning is fundamental to promises made.
