Thursday, February 18, 2010

Life Insurance

Now here is a topic that most of us don't like to think about too often. This and estate planning often get ignored for as long as possible. However, if the unthinkable does happen, I don't think anyone of us wants to leave our loved ones hurting both emotionally and financially.

Like everything financial, you should try to keep emotion out of it as much as possible. Maybe even more so with Life Insurance and Estate Planning. I'm not saying that someone selling these services would tug at your heart string on purpose, but...

OK, so the question is how much do we need and what kind? Some people will tell you how much you need without knowing anything about you. Avoid these people. The truth is the amount of life insurance you need will vary depending on the situation you're in.

Life Insurance is an expense and not a lottery ticket. You should only buy what you need and no more. After all, the insurance companies aren't giving this money away!

People should buy life insurance so that when they die, their living estate combined with their insurance proceeds can allow for the proper winding down of their financial affairs and provide the desired standard of living for their dependents. -- The Wealthy Barber

If you are single and have no kids, chances are your living estate (what you own) is probably sufficient. If not, the insurance you're going to need is very minimal. If you're married with 4 dependent children and your wife is a stay at home mom, then your needs will probably be quite a bit higher. There are a lot of people in Canada that either have way too little or way too much life insurance.

Your living estate plus your insurance proceeds must provide for the following:

1. All debt must be paid off.
2. Enough capital must be available to cover future lump-sum obligations.
1. Funeral Expenses
2. College Expenses
3. Enough capital and other sources of income present to provide sufficient cash flow to support your dependents.
4. Inflation.

You should always insure the person or people on whom you or your family is dependent upon. For a single income family, this is the money earner. However, if the stay at home mother/father were to pass then a burden is left with the surviving parent for child care expenses. In this case the stay at home parent should still be insured enough to pay off the debt and to provide enough for child care until the children are old enough to take care of themselves.

If both parents are working and making good money, the insurance isn't really needed for the spouse. There is no financial devastation. If both parents were to die though the children would be left with nothing. So, in this case it makes sense to insure the parents and only pay out when both have passed.

When we think about this, we generally only talk about family members. If you are partners with someone in a business deal though, it may be important for you to consider insuring them as well. Too much to cover here, but just think about everyone who is dependent on you and everyone you are dependent on.

So based on the above, should you insure your children? I think the answer to that is no. Remember this is an expense that it used to insure that the dependents of the insured won't be financially devastated. While this would be very emotionally devastating, it won't be financially. Well no more than any other unexpected expense. You'll recover, but the reverse is not true if you were to die and leave them with nothing.

The only other argument for insuring children is that they may not be insurable later in life. However, only an infinitesimal number of people are turned down for life insurance when they first apply for it. In life you can't avoid all risks. There are alternatives for them if this happens to be the case as well. Personal savings, working spouse, etc.

There are basically two types of Life Insurance, Term and Whole Life. They are exactly what they sound like. One is for a certain term (number of years) and the other is for your whole life. Term is less expensive, but whole life offers an additional bonus in that it has a investment portion.

So, why would I recommend Term? Well for one, the investment or savings that whole life offers is just YOUR money. When you want to use it they offer to loan it to you and charge you interest. Interest on your own money?!? Second, the investment return for Life Insurance is typically not as good as you could get on your own. So if you buy term insurance, you can invest the money you're saving and use it later for free. Finally, eventually you're no longer going to need insurance. Your children will leave home, your debts will be paid off and your assets will more than cover any final expenses you have.

The Wealthy Barbers advice: Buy renewable and convertible non-participating term insurance. This gives you more flexibility than you'll probably need.

A mortgage life insurance is just a life insurance policy with a declining balance. It may be cheaper than a standard life insurance policy, but make sure you are comparing apples to apples.

Banks and auto loan companies will often want try to convince you to insure your debts as well. This may or may not be a good idea, depending on your situation. When your accounts are settled they will take your debts from any assets you have. If you don't have enough assets to cover your debts they won't be passed on to anyone unless they are co-signed. So the only debt you'd be leaving behind is your funeral costs. So if you don't have any assets or insurance to cover your accounts, why would you care if the loan is paid either?

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