Like annuities, the subject of life insurance tends to be one of the most controversial, hotly contested financial planning topics, often sparking debates bordering on fisticuffs between purveyors of policies, and those who eschew the juicy commissions such policies frequently pay. (Annuities, by the way, are actually life insurance policies, similarly high-commissioned and perennially controversial).
This is unfortunate, since life insurance is an incredibly valuable product, needed by millions, and for which there truly is no substitute.
If a breadwinner – or a pair – dies, income stops and family financial security is at severe risk of grease spotting. For many families, life insurance is an even more fundamental need than homeowners or auto insurance. It is also far more mystifying. The spectrum of policy types – many if not most of which lean dangerously tangential to actual typical need – is bewildering, and determination of the actual amount which should be insured for can seem downright Stygian, not only to consumers but, sadly, to the legions of sparsely-trained agents who purport to serve them.
Instead of Einsteinian analyses estimating to the penny the sum needed to replace lifetime income, buyers may be more likely to hear something like “most of my clients go with the million-dollar whole life…whatcha think, chief, don’t cha need the million-dollar policy? I know what she thinks…”
Except in very rare cases where it’s cost effective and important to carry cash value insurance to advanced old age – and these days these are so rare as to not merit mention here – term insurance for a term matching the period of economic risk is the way to go. Typically, this period is the number of years remaining until a breadwinner’s retirement.
To my view – and to many other more learned others’ – the proper way to view the life insurance need is the so-called “economic value of a human life” approach. In essence, (and forgive the Vulcan cold heart here), this approach equates a breadwinner with an income machine, and then discounts the projected cash flow stream, inflation adjusted, to the present to determine the lump sum that would suffice, appropriately invested, to replicate that income for dependents should said breadwinner depart for that big cash flow machine in the sky.
While perhaps at first blush daunting to some consumers, this math is actually pretty simple, and modern financial planning software can factor in all manner of complications, including projected rising income as one flies a career path, the impact of existing assets and legacy goals, the whole shebang.
The biggest fly in the financial ointment is often confusing the whole shebang with the murky allure of whole life (and other cash value variations like universal and variable life), policy forms which pay handsome commissions to sales agents, but often introduce other (often unneeded) features which increase costs but do not facilitate adequate levels of coverage. In other words, this kind of insurance is often so much more expensive, per dollar of death benefit, than the basic term that most consumers need, that buyers (remembering to reserve cash flow to keep making that mortgage payment) often can’t afford to come close to buying enough death benefit to cover that whole shebang. This can result in dangerous fire-play, if a breadwinner dies leaving only the death benefit from a gold-plated but Lilliputian cash value policy. To misquote Zig Ziglar (who, after all, was referring to sales reps, not buyers), under-insured decedents “have skinny kids.”