It feels impossible to put a number on your life, but that’s exactly what we’re talking about when it comes to life insurance worth. How can we determine our worth when it comes to life insurance? There’s a lot to know when it comes to preparing for your future, but we’re here to help you navigate it. Stop worrying about your future and let us help you put control back into your hands.
The Value vs. Need Approach
In general, there are two good methods to figuring out your life insurance needs. The first approach is to add up all of your future expected income and then adjust it for your incurred expenses and timing (something called discounting). You then produce a lump-sum value of your expected future earnings. This approach is what is called the Human-Life Value Approach. If you are young and have high earning potential, the number will be large. If you’re older and have lower earnings, the number will be smaller.
In contrast, is the second approach where you look at your obligations. This includes outstanding debt, dependent care, spousal support and so-on. Doing this allows you to determine how much money is needed to maintain your current standard of living without your income. This is called the Needs Approach. A larger family, higher standard of living and younger age increase the calculated insurance need.
There are other approaches, however, they tend to produce an inaccurate number when you take into account your specific circumstances. Therefore, we suggest that you implement either a value or need-based approach.
Ways to Avoid Life Insurance
Thankfully though, if you are not a fan of life insurance, you can self-insure. This means having a plan in place on how the remaining dependent(s) will be able to pay for the things they need. This might involve a combination of a stay-at-home spouse going back to work, utilizing investment accounts, reducing expenses and other adjustments. If you are older and have fewer obligations, this may be your best approach. For younger people with families, it’s often difficult to come up with a workable solution to self-insure.
Lastly, you may simply not have a life insurance need anymore. This is typically the case in retirement for individuals and couples who have saved meaningfully for retirement throughout their working career. At this point there are typically few obligations to cover, and enough assets to take care of a surviving spouse.
Other Life Insurance Uses
Likewise, there are some other ways that you can use a life insurance policy. However, these strategies are typically more complex. Therefore, they’re outside the scope of this article to explain the nuances. We encourage you to stay tuned for the next articles in this series where we’ll talk more about them. The other strategies include: Irrevocable Life Insurance Trust (ILIT), Additional Retirement Savings, Estate Creation, Key Person Insurance and Tax Optimization. To give you a brief idea for what’s to come, we’ve outline the basics to each of these strategies.
First up is Irrevocable Life Insurance Trust (ILIT) which is a way to avoid estate taxes by setting up an insurance policy inside an irrevocable trust. This is only applicable to Very High Net Worth individuals ($10M plus) with a current estate tax exclusion amount.
The next is Additional Retirement Savings. Here we have a cash-value life insurance policy. This can be set up as a means to contribute money to a tax-advantaged account. Premiums are paid after-tax (no immediate benefit), and in the future withdrawals are first made to basis. After that withdrawals continue as policy loans. These are non-taxable distributions! There is some risk here as the policy needs to stay in-force until death to avoid taxation on the loan distributions. This is applicable to high-earners who need life insurance.
We then have Estate Creation. If you want to pass on a known amount of money to your heirs, or a cause you love, a second-to-die policy is often the most practical and cost-effective solution! The payout occurs at the death of the second named insured. This reduces cost of the policy, as typically one insured will significantly outlive the other,
Key Person Insurance is for if you own a business and have a person whose death would have a substantial negative financial effect on the business. Thankfully, a life insurance policy can cover that gap. These can get complex from a tax perspective, so be sure to consult a qualified advisor!
Finally, we have Tax Optimization. If you have pre-tax retirement assets and would like to pass some of your wealth on to a charity, you might benefit from this. Here you set up a life insurance policy that pays out to your heirs and makes the charity your pre-tax account (IRA, 401k, etc.) beneficiary. This way your heirs pay no tax (life insurance benefits are tax-free) and the charity pays no tax on the pre-tax money. This way you cut out Uncle Sam from being a beneficiary of your accounts.
So What’s Next?
Now you know the theory of how to find out your life insurance worth and need and the possible uses of life insurance. This is just the tip of the iceberg when it comes to life insurance. It gets much more interesting and complicated when you start looking at implementing different policies. There is a lot to know to make sure you have the right policy for you. Don’t get overwhelmed by life insurance, but get in contact with us today! We’re here to answer questions and help you navigate the world of life insurance.
Stay tuned for the next blog in our series on life insurance where we’ll dive into the world of ILITs.