I’ve had a crisis of faith lately. My son’s 39-year-old t-ball coach unexpectedly passed away in late June. He is survived by a wife and three young boys. I didn’t even know him well but cannot stop thinking about the family and their situation. More than once in the last few weeks, I’ve cried out to God, “How could you let something like this happen? What is the lesson to be learned from this?”

Silence.

Deep down, I know God is present, but I cannot feel his presence right now. I am broken and flawed, just like you. Part of me feels like a fraud. The identity of my business is cloaked in faith, so how do I feel connected to my firm when my faith is stagnant?  

As Christians, our level of faith may wax and wane. I’m here for you, no matter where you are on your faith journey.

 

Turn Lemons into Lemonade

Nonetheless, there are two practical lessons that can be drawn from a tragedy:  

1)   Cherish each moment with family and friends, and

2)   Financially prepare for the unexpected.

I cannot specifically help you with the first lesson but have some important technical insights on the second. According to Merriam-Webster, insurance is “a means of guaranteeing protection or safety.”

When you purchase an insurance policy, you’re transferring risk from yourself to an outside third party. In exchange for that transfer of risk, you agree to pay premiums.  

Your insurance coverage ends when you stop paying premiums on a term life insurance policy or disability policy. Whole-life policies usually require significant premium payments in the early years, and hopefully, premiums can stop in later years while the policy remains active or in force. We will focus on term and whole-life policies since flexible premium, or universal, life policies are complex and beyond the scope of this article.  

 

Term Insurance

Term life insurance is my typical recommendation for young families especially. It is the most inexpensive type of policy, akin to renting versus buying a home. You only have coverage if you continue to pay the premiums. Some term life policies have an increasing premium because they assume your earnings will steadily increase. Other term policies are fixed: your premium will remain the same each year for the duration of the policy. Under the fixed policy, premiums are higher if you have a longer term. For instance, your annual premium maybe $1,000 for a 15-year level term but $1,300 for a 20-year level term.  

Large employers typically provide basic life insurance coverage equal to one times an employee’s annual salary at no cost. They also may offer supplemental group policies (i.e. up to a $500,000 death benefit) for an additional cost, but supplemental group policies vary significantly by employer. 

One of my WorthyNest® clients is a federal agent. She paid over $500 annually for $500,000 of coverage as a government employee. We looked at individual term quotes and found a policy with a lower premium (about $450) for $1 million of coverage. She could get double the coverage for less cost using an outside, individual policy! Her employer penalized young, healthy employees in their group life insurance policy. If she were 20 years older, her employer-provided group policy may have been the better deal.  

 

Whole Life Insurance

Compared to term insurance, whole-life policies offer valuable long-term protection. When the whole-life policy is “paid up,” you are no longer required to make premium payments. In the meantime, cash value builds within the policy. You can take loans against the cash value but should be wary of high interest rates.

Here’s another personal example. When starting my career in public accounting, an insurance representative reached out and suggested I buy a life insurance policy. He didn’t inform me about the differences between term and whole-life coverage. My annual premium was $3,000 for $500,000 of death benefit. Much of the premium in the early years paid the agent commission and internal costs. Couple that with mediocre dividends from the low-interest rate environment, and I was left with very little cash value. 

About ten years after starting this policy, I decided it was not worthwhile anymore. My accumulated premium payments were slightly more than the cash value of the policy. I could take the policy “paid up” and reduce the death benefit to about $130,000; my other option was to remove the cash value. I choose the latter. Paying off my car loan and purchasing a new $1 million term life policy ($450 fixed annual premium) provided better bang for the buck.  

 

Level of Coverage

Now that you understand the types of life insurance, let’s shift focus to the proper amount of life insurance coverage. There used to be a rule of thumb among insurance agents that your death benefit should equal a multiple of seven to ten times your annual pre-tax income. Here are three scenarios where this rule of thumb is not helpful:

1.     STAY-AT-HOME PARENTS

If you’re a stay-at-home parent, you are not receiving financial compensation for hard work at home. Following the rule of thumb, you should have no life insurance coverage because your financial earnings are zero. However, your spouse would need to secure childcare and may require other professional services if you unexpectedly pass away. These services include housekeeping, laundry, meal delivery or prep services, and home maintenance. Consider the total cost to provide all these services annually, and multiply by that cost by the number of years your children will require additional financial support. A stay-at-home parent with two toddlers likely needs more life insurance than a parent with two teenagers who will be out of the house in a few years.  

2.     PARENTS WITH YOUNG KIDS

Budgeting as a young family is tough. You are steadily building work experience and often have additional child care and schooling expenses. You may need MORE than 10 times your salary. Consider future expenses and how long it will take to amass enough wealth to accommodate your family’s needs.  

For example, my family has a mortgage, and our three boys are ages 3, 5, and 9. Childcare and private grade school tuition cost about $22,000 annually in total. Bryan and I also plan to send all three boys to Catholic high school, another $15,000 annually per child. That figure doesn’t factor in the costs of clothes, activities, and food for our growing boys. College is incredibly expensive and must be considered, too. After carefully reviewing these expenses and our future earnings, we decided that 10 times annual salary isn’t enough to fund our family’s lifestyle. My husband and I each have coverage closer to 20 times annual salary.  

3.     PEOPLE NEARING RETIREMENT

For term life insurance especially, age is not on your side. Premiums increase substantially in your 50s and 60s. Perhaps you’re within a few years of retirement and you’ve amassed enough wealth to live comfortably. Self-insuring, or using existing assets instead of an outside insurance policy, maybe better.  

 

Need Guidance?

As you can see, insurance isn’t cut and dry. You cannot emergency proof your life, but insurance transfers risk to third parties and might be helpful. Find a fee-only fiduciary advisor who will help select insurance policies in your best interest and act as a liaison between you and an independent insurance broker who sells the policy. There is no financial incentive for a fiduciary advisor to recommend a particular product, company, or level of insurance coverage to clients.

Not quite ready for a one-on-one relationship with a financial planner? Money offers an excellent life insurance guide.

At WorthyNest®, we guide parents through important financial decisions using a values-based approach. Contact us to explore a one-on-one relationship.