It’s time to discuss the facts of life, a sometimes controversial and often uncomfortable discussion. This column will always cut to the core of issues—explaining the facts and, hopefully, providing readers a framework to make intelligent decisions. This week’s column is the first of two that will address life insurance.
It’s always good to begin at the beginning, to quote Lewis Carroll. Life insurance, most importantly, provides an income-tax free benefit, predetermined at time of purchase, should an insured die while the contract is in force. In short, it creates a pile of tax-free money to pay mortgages, fund educations, and provide income.
So before we even get into which flavor might be appropriate for an individual or family, we must first answer the question: Would it be important to have a pile of tax-free money for someone or some institution when we die? More to the point ask: I’m dead, what does my family do now?
Keeping in mind that the no one gets out alive, it’s a matter of when we die, not if we die. Therefore we have to answer this question if we were gone tomorrow, five years, ten years, or at ten years past our life expectancy.
If the answer is yes for any one of the time frames, then a person has a need for life insurance.
Some situations are obvious: A young family dependent on one or two incomes to pay a mortgage, educate children, and amass money for retirement. A couple in the ten-year dash to retirement, with one or two people in peak earning years that are necessary to catch up on retirement contributions. A family with a special needs child who will need expensive support long-after mom and dad are gone.
Others might be less so, but careful consideration reveals a need. A soon-to-be retired couple whose income is tied to a pension and social security benefit that will be significantly reduced should one person die will need life insurance. A family with significant assets that, if no planning is completed, will see a distressingly large portion sent to Uncle Sam in estate taxes.
Others still might decide that none is needed. Income sources are secure and able to cover expenses regardless of life or death, no taxes will be owed to the government, and no one will be left holding a bag of bills should one pass.
Once a need is determined, the question arises: how much? The number one reason people purchase life insurance is to replace income. There are many legitimate ways to determine how much insurance is needed to provide sufficient income for loved ones.
The human life value places a dollar amount on the value of one’s life. It asks the question, how much is a person worth, in dollar terms, to their family should they survive to life expectancy. In technical terms, it is the net present value of one’s future earnings. Believe it or not, we can put a dollar figure on each of our lives. This is what courts do for legal purposes. It provided the basis for the 9/11 compensation fund, which paid an average death benefit in excess of $2 million, according to the ABA Law Journal (Jill Schachner Chanen and Margaret Graham Tebo, “Accounting for Lives: The 9/11 victim compensation fund worked. But what about next time?” ABA Law Journal, August 2007).
The virtue of this method is that it requires relatively simple calculations and no need to understand an expense or debt structure. It merely asks, how long is one planning to be dead, answers forever, and replaces the necessary amount of money.
Another method is a basic needs analysis. It asks, what would I want for my family should I not come home or wake up? This method demands that we pull out a piece of paper and put dollar figures to goals: How much will we need to fund college, retirement, and income for survivors. This analysis requires combining desired income streams and lump sums into a single number. It’s the dollar amount that is needed to keep a family in its own world, should nothing else change.
For young families, the human life value and basic needs approach will produce very similar results, since most of their great life goals—paying off a mortgage, educating their children, and amassing money for retirement—are dependent on future earnings. In later years, human life value may produce a larger number. In both cases, the numbers are usually larger than people expect—we undervalue ourselves—and much larger than most group policies cover at work, creating a need for privately owned insurance.
One method is not right and the other is not wrong, they are simply different paths to the same goal—protecting our loved ones. The important point is to take action, ask the sometimes uncomfortable questions posed in this column, and then do something to protect the people you love.