Modeling Your Life Insurance Plan (a Case Study)
You purchased a life insurance policy years ago after purchasing your first home or having your first child; buying a term policy or basic group life policy through work made sense.
Now you figure, “So long as my premiums are paid on time, I’m done with insurance planning, right?” Not quite!
How much life insurance did you buy?
There are many rules of thumb in the insurance world, the most popular being “buy X times your annual salary.”
But not everyone necessarily fits that mold. Addressing the question of how much life insurance to buy varies from person to person. In fact, this makes a frequent insurance review very important.
Insurance planning is about developing a unique perspective of what you want your policy to cover. Whether it is a term or permanent policy, the objective is to minimize the financial (and emotional) strain due to a loved one’s passing.
Items to consider when selecting an insurance policy:
A mortgage or other joint debts
Household costs of living expenses
Education costs
Gifts and inheritances
Potential tax liabilities (if applicable)
Burial costs and other final expenses
To illustrate, meet the Smiths (fictitious characters we will use to build a fundamental understanding of insurance planning design):
Mr. and Mrs. Smith are in their mid-30s and recently purchased a home for $350,000.
Mr. Smith earns $85,000/year as a software engineer; Mrs. Smith earns $120,000/year as a pharmacy manager. They have three children: ages 7, 4, and a newborn.
Household Debts and Living Expenses
Jointly-held debt. Usually, if there is a co-borrower on debt, both parties are responsible for repaying the debt.
For example, let’s say the Smiths took out a joint loan to buy their home. If one passes away prematurely, the surviving spouse must still repay the debt, a common concern for many couples.
Living expenses. The same goes for household costs — think utilities, cable, internet, phone, food, childcare, transportation, insurance, and money for leisure and entertainment. Losing a loved one and their income presents a real dilemma concerning staying afloat (not to mention the emotional stress).
With little or no life insurance, a family may have to liquidate any savings or even sell the house and move to make expenses more manageable.
Other Goals to Consider
Protecting the children’s education or creating a family legacy may also play a part in an insurance plan, as long as both align with personal goals.
Maybe the Smiths like the idea of ensuring money is available to cover part of their children’s college tuition, but leaving a legacy may also rank high on the list of other items to plan for.
Leaving a Legacy. An inheritance usually is not too a tricky consideration (in theory). The decision is often based on the premium one can afford.
For instance, say the Smiths like the idea of leaving a $25k inheritance to each child. This assumption would be factored into the insurance plan and the Smiths’ budget.
Funding Children’s Education. Planning for college could become a more complicated calculation. Working with a planner, the Smiths should project rising tuition and other education costs over the next 20+ years (i.e., when their youngest would attend college). This calculation may also increase their insurance needs.
Final Expense Coverage. As the term implies, final expense coverage relates to medical and burial expenses—costs a loved one may face just before or right after death.
Again, based on the Smiths’ unique goals, an educated assumption must be made when estimating these final expenses.
The Smiths’ potential needs to consider before pulling insurance quotes:
Enough to cover their mortgage loan
An amount to replace, say, 50% to 70% of Mr. Smith’s income (learn more about Replacement Income)
An amount to replace, say, 50% to 70% of Mrs. Smith’s income
Added coverage for college costs if not already funded (see Cost of College)
Additional coverage to leave a legacy for each child (see Leaving an Inheritance)
Enough to cover Mr. and Mrs. Smith’s final expenses, for example, a proper burial (see Estimated Cost of Funeral)
So, how much insurance do the Smiths need?
As you can see, many factors are in play when forecasting one’s insurance needs. The takeaway here, though, is how important it is to evaluate (and re-evaluate) insurance needs over time. Hopefully, the Smiths’ scenario helps form a basic understanding of what a thorough insurance plan looks like when forecasting coverage amounts.
As part of our premier planning package, we will work together to design (or reevaluate) your risk management plan by:
Reviewing all existing policies
Analyzing and projecting coverage needs
Recommending suitable coverage amounts
Helping you shop and compare carriers
And as a fee-only firm, we DO NOT sell insurance or collect any referral fees for working with carriers. You can count on us for an unbiased opinion and plan suggestions.
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