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Financial Planner

‘How Much Is Enough?’

MentzerEarly in my former career as an insurance agent, I offered a detailed presentation to a young couple with a new home and an even newer baby. The wife listened to every word, nodding her head at all the right places, but her husband simply sat there with arms folded defiantly across his chest. When I asked for their responses, the husband said, “Life insurance will only make sense for us if I die.”

Most of us acknowledge that death is more than an “if” proposition. But while death is inevitable, life insurance is not. In truth, the need is greatest when there are young children in the family, there is only one breadwinner, or when resources are lacking to support the surviving family members for a significant length of time.

Life insurance is designed primarily to replace income lost at the death of a wage earner. That’s why financial planning textbooks today suggest the average person should own enough life insurance to replace eight to 10 times his or her annual take-home pay. Can’t you just feel the “sticker shock” setting in?

For most, it makes more sense to sit down with a trusted financial adviser and do a computer-based analysis of one’s life insurance needs. This starts with any immediate needs at death, such as funeral expenses, final medical bills, unpaid debts, or estate taxes. Next, how much will be needed to cover a readjustment period, perhaps to finance a move out of the church parsonage into a different residence, or to provide time for family members to find a job?

The questions then move to ongoing financial needs: monthly bills, day care costs, mortgage payments, college savings, and income to assure that the surviving spouse can live comfortably. The final figure will represent the total dollars one’s survivor(s) will need.

Finally, the analysis will include current financial assets savings accounts, retirement plans, mutual funds, real estate investments that could offset projected needs. Comparing assets to projected costs reveals how much life insurance will be needed to make up any difference. Since needs vary over a lifetime, it’s important to update this analysis periodically. As one accumulates financial assets, the need for life insurance often decreases.

All life insurance policies agree to pay an amount of money if you die, but all policies are not the same. Term insurance is basic coverage for a set number of years, often with the ability to renew the policy at the end of the stated “term.” Since there is no investment or cash value component to term insurance, it is often the least expensive option, especially at younger ages. While premiums vary by company, they increase as one ages, often dramatically after age 50.

At the other end of the spectrum is whole life insurance, which guarantees lifelong protection as long as the policy remains in place. The premiums do not increase as you age, but remain level, and are always higher than term insurance. For a healthy 30-year-old male, $100,000 of term insurance might cost $250 per year for 20 years. That amount of whole life insurance for the same person might average $607 per year, but the rate would stay constant. By age 50, his cost for $100,000 of term insurance might increase to $825 per year.

In the early years of the whole life policy, the payments not used to purchase the death benefit or pay policy expense charges accumulate as interest in the “cash value” account. In later years, the policy’s cash value assists the premiums to meet the cost of the insurance. In between are a variety of life insurance contracts that combine features of both term and whole life coverage. (For basic information, visit the LifeBook offered by the Kansas Insurance Department (pdf).

One caution here. The main purpose of life insurance is financial protection. Beware financial consultants who recommend life insurance products as investments or asset accumulation tools. You would be better served by considering other financial products to meet those goals.

James G. Mentzer, CLU, ChFC, has been a financial planner since 1986. He is currently director of planned giving for the United Methodist Foundation of Raleigh, N.C.