The Brooklyn FI Guide to Life Insurance
By John Owens, CFP, EA, ECA
When we meet with new clients, they’re often engaging us because they’re about to experience a particular life change - switching jobs, an impending IPO, starting a family or business, and buying a new home. Any of those events can trigger the need to reevaluate life insurance coverage and adjust your benefits. It’s important to have a framework that works, for most cases, and understand some situations in which the ‘typical’ life insurance framework breaks!
For most of our clients, the purpose of life insurance is to replace income in the event of an untimely death. Sorry, that’s not the most cheerful sentence - but that’s why we have life insurance - to provide a safety net for really bad things.
Most of the time, the real risk is largely constrained to a certain timeline - needing to replace income during working years, until the kids are college educated, or when the house is paid off. Beyond this point, life insurance may be superfluous - providing liquidity when it is otherwise unneeded.
So, how do we evaluate life insurance needs?
First, we need to build your financial plan - what are you spending, what are your goals, what happens with equity compensation if you or your partner were to pass, etc. That helps us chart a course for the next 50+ years of your cash flows and evaluate the various risks.
From there, we also need to include your current life insurance coverage - policies you own, coverage provided by work, and perhaps even group policies from associations you belong to.
Then comes the tricky part - we need to assess what would be different if you or your partner were to pass. What expenses would increase - such as childcare or taxes? Which expenses would decline - discretionary expenses, car payments? How would this affect the earning ability of the surviving partner - could they keep working? Would they need to cut back?
Thankfully, we can make some assumptions about changes to expenses and income to assess how much insurance we really need and evaluate any gaps in current coverage.
So, what type of insurance do we get, and for how long?
In most cases, the “need” for life insurance is finite, we don’t need coverage until age 85, but we may need coverage until 60 when we’re planning to retire and the kids will be finishing up college. Or, we may want some coverage until 68 when the 30-year mortgage should be paid off.
In case such as this, we often want to opt for term insurance - insurance for a specific period of time. A 30-year term policy with level premiums means you pay the same amount each year for the next 30 years for the level of coverage you select. And, assuming you survive the term, at the end of 30 years you stop paying your premiums and the coverage ceases.
And if we need more coverage later, how does that work?
That’s a pretty common scenario - perhaps today you only need $1M in coverage, but later on you have two small kids, a bigger mortgage, and much higher expenses. It may make sense to add another $1M in coverage. But that additional coverage might only be needed for 20-years at this point. So you may have multiple policies with different terms that overlap to account for the fact that the financial devastation of a sudden passing could vary at different times.
So, when would it make sense to have life insurance that’s permanent, rather than term, that you always have in place?
While it’s impossible to list all the scenarios when this might make sense to have permanent coverage, a few common examples come to mind.
Estate tax issues: if you anticipate having to pay estate taxes, especially if there’s a lack of liquidity in your estate (a small family business, etc) having life insurance to cover the estate taxes could be crucial to avoid an unnecessary disruption.
Special needs: if you have a child or family member with special needs that may need to be taken care of in the future, ensuring there’s cash to provide for that care could also be a reason to get permanent life insurance.
Buy-sell agreements: permanent life insurance can often make sense for business partners to buy eachother out in the event one of them passes away.
Should life insurance function as an investment in addition to an insurance product?
Unlike hybrid cars, hybrid investment and insurance products don’t often make sense. Unfortunately, many of these products have high commissions for salespeople - who have a significant financial incentive to sell them. While we don’t want to paint entire swaths of the insurance industry with broad strokes, it is important to start any insurance analysis first with your goals, understand your needs, and determine the most efficient way to get that coverage - rather than looking at products as a one-stop solution for everything.
And so, can Brooklyn FI help with insurance?
Yes, we can help you understand which type and amount of coverage makes sense based on your financial plan, and then we can refer you to insurance professionals we partner with that aren’t compensated on commission or chasing down the next big sale - but rather working to implement the plan we develop. If you have questions, reach out to your Brooklyn FI advisor or, if you’re not a client, learn more about us here: https://www.brooklynfi.com/discovery