As the old joke goes, the only two guarantees in life are death and taxes.
In these updates, I obviously spend a lot of time talking about taxes.
But the other part of that axiom is a subject that most people don’t want to talk about, let alone actively plan for. But plan for it you should.
And that planning process should absolutely include a conversation about life insurance, especially if you have children.
To get that conversation going, let’s start by understanding the purpose of life insurance.
The Purpose of Life Insurance: Consider This Connecticut Resident
“If I cannot do great things, I can do small things in a great way.” – Martin Luther King Jr.
When it comes to planning for your inevitable demise, there are lots of considerations you need to take into account. There’s no one-size-fits-all approach to estate planning that is absolutely guaranteed to work for everybody, and that goes for my Connecticut clients as well.
One of the most common considerations, however, has to do with life insurance. We’re not just talking about how much you need, what type, and who the beneficiary should be, but even whether or not you need life insurance at all.
The Purpose of Life Insurance
If you’re in Connecticut and you’re asking yourself Do I even need life insurance?, a helpful place to start is understanding the purpose of life insurance.
While some people may think of life insurance as something that will make somebody else rich once you croak, that’s not the ideal way of looking at it.
Instead, let’s start with something more simple: Your income.
You go to work to make money, which you then use to pay for your living expenses, fund your retirement accounts, and otherwise spend as you like. When you die, that income goes away.
The sudden vanishing of that income actually brings us to the purpose of life insurance. This financial product exists for the purpose of replacing income upon death. Yes, the lump sum payout may make your beneficiary wealthy overnight, but the primary goal of that windfall is to enable the continued payment of living expenses by your heirs after you’re gone. This is why life insurance was originally created and is the primary purpose of life insurance in the broader financial marketplace … something for my Connecticut clients to be thinking about.
With all that said, the question of whether you really need life insurance boils down to this: Does somebody else depend on your income to support them?
If the answer to that question is no, then life insurance becomes a purely optional thing for you. It doesn’t mean a life insurance policy is inappropriate for you — perhaps you want to leave a large sum to your favorite Connecticut charity, for example. But the core need for life insurance isn’t really there.
Supporting Your Family
If you have mouths to feed other than your own, then life insurance really becomes a backup plan for supporting your family in the event of your death. Replacing your income is particularly important when you are the sole or primary wage earner in your household, but it definitely applies to all income in your family that is used to pay for necessary living expenses.
In the unfortunate event of your death, your family is obviously going to be dealing with a tremendous amount of grief and stress. Life insurance basically helps reduce or eliminate yet another source of anxiety that families all too frequently deal with after the death of a wage earner. Maybe you even know someone who needs to know that the primary purpose of life insurance is to help families avoid added stress in the wake of losing a loved one.
If you already have significant investment assets, this may not be a consideration for you. In this case, you can “self-insure” because your existing assets can be used to provide for your family after you’re gone. If you don’t have enough assets to cover your family’s needs, then a small life insurance policy may be advisable in order to cover the gap.
How Much Life Insurance?
Once you’ve determined the purpose of life insurance and that you or your Connecticut friend do need it to support your/their family, the next obvious challenge is to determine how much coverage you need.
This can be a really hard number to pin down, and there certainly is no absolute consensus on this. In general, many financial experts advise that you have enough life insurance to effectively replace 10 years of income.
In addition, you may also wish to purchase enough coverage to:
- Pay off the mortgage on your home.
- Eliminate all other debt, such as car loans and credit cards.
- Cover college for each child at the estimated future cost of attendance.
After adding up all these dollar amounts, you then subtract the value of any life insurance policies that are provided elsewhere, such as by your employer, and subtract out investment assets. The amount left over is your desired life insurance coverage amount.
While obviously an awkward topic of conversation, determining your life insurance needs is a critical component of smart financial planning. We would be happy to help you evaluate this need and also to connect you with an insurance agent we love who can help you with choosing a policy.
Emelia Mensa CPA