Life Insurance - Essentials Only
Updated: Jul 21
Life insurance is a foundational component of financial planning. The importance of having sufficient income loss protection is hard to overstate. However, with so many life insurance options, it's easy to get overwhelmed and delay the purchase of necessary coverage.
Life insurance is really just one form of managing the risk of income or productivity loss. In this case, it's managing the risk that income or productivity is lost due to death. Another form is managing the risk that income or productivity is lost due to disability. Both scenarios are centered on the idea that the individual or their dependents are reliant upon a certain amount of income to sustain themselves.
Many employers offer life insurance, such as the Servicemembers' Group Life Insurance (SGLI) for military members. A benefit of employer-based programs is that few people opt-out and almost all employees carry a basic level of life insurance at a reasonable or no cost. The downside is that many employees stop there and neglect to conduct a more thorough analysis of their needs. For the youngest and most senior employees, the baseline insurance amount offered through an employer may be excessive. Employees aged in their middle years, typically with dependents, may have substantial need for a supplemental policy. Business owners may have outsized needs for insurance relative to their employee peers.
Human-life value or needs-based? If someone has dependents, the need for life insurance is almost without question. The need for a chief income earner to carry life insurance is fairly obvious. An easy rule of thumb is to use the human life value approach and multiply after-tax income by the number of years needed/desired to support dependents. This often yields higher than necessary estimates, which is why most financial planners utilize the needs-based approach to develop a more detailed and nuanced prediction of future needs.
It's important to remember that stay-at-home spouses or caregivers carry intrinsic financial value due to the value of their uncompensated work. Kids, aging parents, pets and a physical home may require ongoing care or maintenance that would need to be outsourced due to the death of a stay-at-home caregiver. This care is usually needed longer than initially estimated, often into at least middle school to help manage meals, transportation and days when school is not in session. RVPF recommends using location specific averages for determining the cost of a nanny or other care options for durations that are specific to each family. Even if parents think that they could turn to a childcare center, childcare scarcity may require that a nanny be secured to allow the income-earner to return to work. In the case of aging parents, the local costs of home-based care and transportation to necessary medical appointments should be evaluated. Single parents may desire to match their life insurance to the amount needed pay for a larger home for the designated guardian of their children. Two income households without children may want to alleviate the burden of a mortgage for their loved one even though the surviving spouse may be financially independent. The wide range of life insurance needs warrant a conversation with a fiduciary advisor.
Temporary or permanent coverage? The choice between term and permanent life insurance is complicated, due in part to the level of sales training provided to commission-based agents. Nonetheless, term insurance fulfills the primary objective of getting needed insurance at the most cost-conscious rates. Permanent insurance carries particular value for households that have negative family health history or would benefit from forced savings. As a planner who formerly believed in exclusive use of term life insurance, I've softened to the idea of a diversified life insurance portfolio. This is the a result of witnessing how life insurance benefits are something like a warm hug from a recently deceased loved one, even in the presence of an otherwise healthy investment portfolio. I attribute it to the fact that life insurance benefits are pretty straightforward in that they are typically (not always) distributed quickly and without tax liability. Still, I recommend only modest permanent policies, due to the high cost of premiums compared to term insurance.
Fixed or adjustable: Life insurance needs are constantly changing, sometimes in predictable and other times in unforeseen ways. In general, though, we can expect that life insurance needs decline over time as a result of life insurance mirroring the amount of income or uncompensated productivity remaining. As a result, it can be anticipated that a tiered life insurance strategy with several multi-year term policies can manage the risk of income loss at the lowest cost. For example, a parent of young children may choose to tier three policies with 10, 15 and 20-year terms with at least the longest term including guaranteed renewable or convertible to permanent features. These features allow policies to remain in force in some form without additional medical exams, although the premium will still increase due to age. All policies should be selected in light of inflation over time. Permanent policies, such as variable universal life, may have an increased death benefit due to an improvement in the policy's cash value.
How to buy? Life insurance can be purchased in a number of ways.
Better: Through employer during initial employment period or open benefits season. (Military members may increase or decrease their SGLI at any time.)
Better: Through a traditional in-person broker. RVPF recommends using an independent agent, rather than a captive agent who writes policies for a single insurance company.
Good: From an online agency such as Policy Genius, LadderLife or BrightHouse Financial.
Try to Avoid: Unsolicited sales from an old friend. These are generally commission-based agents who are new to the field and are encouraged to connect with friends, family and acquaintances to meet initial sales goals.
Have questions about whether your life insurance portfolio is the best fit for you? Your thoughts and questions are always welcome!