Life insurance is one of the most commonly misunderstood and under-used financial products available. Why is that? Most people don’t understand how, why, or when to use life insurance. Life insurance has two main benefits.
First, life insurance like all types of insurance is designed to protect against economic loss. With life insurance the loss protected against is the economic value of a human life. This life or “Capital” can be defined as the future earnings, current debt obligations, or intellectual value of a person. In essence, life insurance is a hedge for human capital.
Second, it provides a tax free death benefit that replaces the human capital value of the insured at death. Obviously it doesn’t replace the person or make up for your loss, but it does ensure that an economic loss isn’t added to the physical and emotional loss already suffered.
Whether you are a newlywed, empty-nesters, or retiree just about everyone has a need for life insurance. In determining how to use life insurance it is important to remember two specific questions. First, how much insurance do you need? Second, how long do you need it?
Many people assume that you can never have too much insurance. Unfortunately many in the life insurance industry would like you to believe the same thing. The reality is that there are two primary methods that can be used to determine how much life insurance you need. The first is the Income approach and the second is a Needs or Expense approach. Neither is perfect, but they will both give you a very good estimate.
The Income approach uses your current income and an assumed inflation rate to determine how much insurance you need to protect that income level over a specific time period. The Needs approach uses your current expenses and an assumed inflation rate to determine a minimum income level needed to meet those debts over a specific period of time. Both can be further influenced with the need for future savings, investments, college tuition, and
Are there any folks in particular careers or life stages who should buy this insurance? Most people need life insurance. The question is how much and how long. This will determine how much needs to be temporary and permanent.
Just like buying anything else, it is important to be informed. There are three specific tips you should follow when purchasing life insurance.
First, you need to know is that not all insurance agents are created equal. Some agents are required to sell only one company’s products. This type of an agent is called a “captive” agent, because they can only offer their companies products. As such, they tend to see everything as it relates to their products, not necessarily your needs. Although many of these agents are honorable, ethical, and educated in there filed, it is normally easier to just avoid captive agents as much as possible.
Second, you need to know is that there are two basic types of insurance – temporary and permanent. Another name for temporary life insurance is term insurance. It is important to know what kind you need and how much you need of each type. Most people need a lot of term and a small amount of permanent insurance. This need tends to shift over time and may move completely to one side of the spectrum or the other.
Finally, you need to understand is that the amount of insurance you need changes often. Things like losing a job or getting a pay raise, marriage, divorce, births, deaths, and having children all affect the amount and types of insurance you need. It is important to get regular reviews to ensure that you aren’t over or under insured.
Two things that may surprise you about life insurance, one you may be surprised to learn is that insurance products all have different features, called riders that provide different benefits beyond the death benefit. Some of these riders are disability income, waiver of premium, return of premium, and accelerated death benefits. The riders can be free or add to the overall cost of the insurance and may not be needed by everyone, but they should at least be presented and considered during your selection process.
Two, it is important to make sure that you are dealing with a true “Financial Professional” and not just a salesperson. You can do this by checking the license status and any complaints your agent may have had on your states department of insurance website.
You should also ask your advisor what professional designations hold, what specialized training they’ve received, and what professional organizations they belong to. Ideally, they will have a CLU, ChFC, CFP® or other similar designation. This shows that they have taken the time to receive extra training and education about the products and services they offer. They should be attending regular Continuing Education (CE), seminars, and industry events to stay up-to-date on laws, products, and services available.
Your advisor should also be a member of a professional organization like the National Association of Insurance and Financial Advisors (NAIFA), Association of Advanced Life Underwriting (AALU), or the Million Dollar Round Table (MDRT). These organizations require their members to adhere to stringent codes of conduct, receive additional training and CE, and participation in peer reviews or mentoring programs.
So what should you do? First, find a “Financial Professional” and conduct an interview with them. Not sure how to do that – read my earlier post on “Asking the tough questions – how to interview a financial advisor.” Second, don’t delay – there is never a reason to wait on making your financial future better.
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