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« Financial Planning | Main | A Million Dollars? »

Can You Say Insurance?

Insurance is such a boring topic, don't you agree?  You rarely hear anyone talk passionately about insurance in the theoretical sense. Occasionally, if someone needs it and cannot get it, or if someone has been the recipient of an insurance settlement, they may speak of it with a bit of passion, but most people would really prefer another topic for polite discussion.  Of course the current discussion about health care has generated a bit of passion, and considering the difficulty that our elected reps are experiencing now in keeping the discussion about health insurance civil, I will confine my discussion to life insurance.  Insurance is really just a drain on one's finances; that is until one really needs it, and then it can be a wonderful, life-altering asset.  All types of insurance are basically arrangements where the buyer of the insurance transfers the risk that something bad may happen to the seller of the insurance.  The logical use of insurance is to insure that which we cannot afford to lose.  I can afford to lose my watch thus I do not have it insured (unless it falls under the protection of my home owner's policy; I'll have to check if I ever lose it.)  I can afford to lose my lawn mower to fire, but I cannot afford to lose my house, so I have my house insured.  When I was a young man, my wife and daughter could ill afford to lose me and my salary, so I had life insurance; that is the way we logically use life insurance.  But how much life insurance does one need?  The answer to that question depends on what one needs to insure.  I want to look at two ways young families typically use life insurance.

Many buyers of life insurance want to insure that their children have the opportunity to attend college if they are no longer around.  College costs continue to rise, and they do present a challenge to young families who may be struggling with other financial  issues.  Last year the average cost to attend a public university in the US was $6,585.  That was 6.4% higher than the prior year.  If we assume that college costs continue to rise at 5% per year, that number becomes $10,726 in ten years.  A college education at a private institution can cost much more, over $25,000 last year.  Thus a family has to plan on having nearly $50,000 on hand to fully finance a four year program at a public university ten years hence.  Of course this assumes that no scholarship or other financial aid monies will be available, and that is not likely to be the case.  Last year over $143 billion dollars of financial aid was available to college students.  Many young families, when assessing where to spend their insurance dollars, may decide that they cannot afford to fully insure college costs, and for many this may be logical.  A logical course may be to allot a portion of their insurance money to college costs and assume that their child will be responsible for a portion as well, especially in light of the amount of financial aid available.  Additionally, a disciplined college savings plan will erode the need for college insurance over time.  So buying life insurance to insure college costs may be a luxury that many cannot afford and may not be required to the degree that some insurance sellers would lead us to believe.

A more important use of life insurance may be to simply replace the income of the insured.  (Long term disability is more of a threat to young families, and disability insurance should also be on their agenda, but that is a discussion for later.)  But again we face the issue of determining just how much insurance will be required.  Many financial pundits use the rule of thumb that says that life insurance should be eight to ten times the amount of the annual salary of the life being insured.  This may be a good starting point, but a more detailed analysis should be pursued.  A number of questions need to be answered before arriving at a logical figure:  Does the surviving spouse have a career and will he/she continue to work?  Will there be child care expenses? How many children are dependent on that income?  Where does the family live and will they continue to live in the current home or apartment?  Are there extended family members available to help?   How many assets are currently available?  How long is the insurance money expected to last?  Can an inheritance be expected at some point in the future?  Etc., etc.  And finally, and most importantly, what will be the spending needs of the surviving family?  An honest, thorough discussion with a really dedicated life insurance agent, one dedicated to serving the needs of his clients, should lead to a logical answer; and that would be an answer that not only fits the needs of the family, but one they can afford.

Every good financial plan begins with a discussion about insurance.  Risks need to be assessed and adequately addressed before the discussion about investments even begins.  Additionally, life insurance should not be viewed as an investment.  Most, if not all, life insurance sold as an investment, makes a lousy investment.  Most young families have no need for whole, or universal life insurance.  Term life insurance has gotten progressivley cheaper over the past few years, and term life insurance provides the most coverage for the fewest dollars, and thus should be the vehicle of choice for most.  Remember, another wonderful characteristic of life insurance is that Uncle Sam does not tax it when the beneficary receives it.  It comes tax free!  Though it is never pleasant to consider one's demise, knowing that one has provided for those dependedent on him/her with sufficient life insurance takes a bit of the sting out of the process.


Fly/Drive Safely

15 September 2009

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