I met with a young couple a few weeks ago. They have 2 young children, both work full time, and were ready to learn more about how to develop a financial plan.
In their middle thirties, Tanya and David have a combined annual income of $119,000. They have student loans of nearly $58,000, some credit card debt, and a new mortgage of $190,000. The couples’ situation is familiar, and not uncommon. Recently, a friend’s serious illness motivated them to contact my office.
Both Tanya and David had some awareness of the issues they wanted to explore. Their parents had encouraged them to establish a relationship with a financial advisor to begin developing a financial plan, including insurance and employee benefits planning, complemented with legal strategies to help protect them for the future.
Basic Forms of Insurance Planning.
The first question Tanya and David considered is What type(s) of insurance do we need? Based on their life circumstances and age, we focused on two forms of protection: Life and Disability Income Insurance. (Property & Casualty Insurance is an entirely separate type of planning, not covered here.)
Life insurance protects loved ones when you die. It can help your survivors pay bills, cover the cost of college, provide a legacy to your heirs or provide an income stream for your heirs to live on. The simple question to ask is – “Would your death cause a financial need or crisis for your loved ones, and would it alter your family’s goals?”
Two Types of Life Insurance
There are two basic types of Life Insurance. Permanent and Term (only a death benefit). Permanent Insurance generally will last all your life, can grow cash value internally and costs more than Term. Term Insurance offers no cash value, generally is much less expensive and is really designed for limited periods of time.
Beneficiaries are determined at the time of purchase, and can be changed. Both types have great value and sometimes a combination of different policies can play a useful role in protecting the various risks faced in life, including an untimely death. Some permanent type policies can grow cash value on a tax deferred basis. It is not uncommon for a policy holder to borrow from the cash value during their life time to meet an unexpected or large need, such as college tuition. In addition, a thorough review of newer types of policies might yield creative and innovative solutions that are less expensive or more comprehensive.
Disability Insurance is an additional type of insurance considered by Tanya and David. Disability insurance is a form of income protection coverage. If either spouse could not work due to illness or injury, it is typical for financial stress to ‘hit hard’ sooner than later. Disability insurance coverage provides a monthly income, often tax free, when the wage earner cannot perform the main duties of a regular occupation. It can be integrated, for those who qualify, with limited benefits provided through Employer Based Social Security and New York Disability Programs. Disability Insurance is designed to provide income after you have used employee benefits to remain as financially sound as possible. Insuring income might actually be as, if not more, important than insuring your life, or car or house.
How Much Insurance to Buy
The second question to consider in purchasing insurance is How much insurance should we buy? To help Tanya and David determine how much life insurance to consider, I chose an approach that included debt elimination for the surviving spouse (mortgage/credit cards/student loans/cars), four years of college tuition for each child, adjusted for inflation (they had both stated that they expected their children would attend college), and 2 years of the spouse’s income to ensure that the family could continue their lifestyle while adjusting to a loss.
While this approach at determining insurance need is rather concrete, it provides a starting point to address the ever changing needs of individuals and families. Unexpected situations can, and do, happen to all of us, so it is better to be prepared than not. Through a deliberate plan, your goals can be reached and hopes fulfilled, in spite of tragic events.
Understanding these few simple aspects of insurance policies can help protect you, your income, your family, and your investments, possibly making the difference between financial well-being and or serious economic challenges for you and your family should the worst occur.
Working with an insurance professional, you will be able to examine your needs, explore cost effective and comprehensive approaches to meeting those needs, and determine the best strategy to reaching your economic goals.