Wealth Planning News
Vol. IV, No. 11
Purposes of Life Insurance
Insurance professionals all talk about life insurance as if that term meant something. Like many generic terms it is nearly meaningless. A more meaningful descriptive phrase might be:
A bunch of money going to
someone when you die.
To find the real purposes of the insurance, planners (lawyers, financial advisors, accountants, and insurance professionals) have to help you focus on the reasons you want a bunch of money going to someone when you die.
For simplicity, forget some of the terms you normally hear for insurance, and consider some possible real purposes of life insurance.
The first purpose of life insurance is to meet needs of your dependents for living expenses for the life style you want them to enjoy. Think of this type of life insurance as needs insurance. Some people call it income replacement insurance. Imagine yourself as a money machine. This machine cranks out money week by week. The money is used to meet the living needs of the people the machine supports. If the machine breaks and cannot be repaired, the people the machine supported need a bunch of money to meet their needs thereafter for a long time. So the people who are supported by that machine need death insurance on the machine.
The amount of money your loved ones need depends on how much they need for how long. If they have a need for this bunch of money at your death, life insurance on you is an excellent way, and in some cases perhaps the only way, to meet that need. The alternative is to let your loved ones have a drastically reduced lifestyle, or force your spouse to remarry or live with someone if only for economic security, or in some cases let the government meet the needs of your loved ones
Rent or Buy Needs Insurance?
Consider the duration of your need. If the need is short term, say for another five to ten years, you can rent the needs insurance. Most pure needs insurance can be rented.
Insurance professionals talk about term insurance when they really should talk about rented insurance. In fact most people in America, and even many insurance professionals, think only of needs insurance when they hear the term life insurance. And since meeting needs of loved ones is the only purpose they see for life insurance they naturally think that people should never get anything but term insurance. Whenever we hear the phrase, “Buy term and invest the difference,” we know the person saying that is thinking only of needs insurance and is recommending that the insurance be rented instead of purchased.
But just because needs insurance can be rented in many cases, it does not follow that it always should be rented. Life insurance has other purposes than being needs insurance. And for certain reasons the economic value to you may be greater if you buy the policy rather than merely renting it for a term. How much more do you have to pay to buy insurance compared to the amount you have to pay to merely rent it? Is the difference that remains later large enough to justify buying instead of renting? Could you have done better buying some other investment? And more important in most cases is the question of whether you actually would have bought some other investment? If not, buying instead of renting the insurance was like a forced savings program. We have some worksheets that usually show it is better to buy insurance, rather than rent it, if you will want it for ten or more years.
If you die your loved ones might have some immediate large cash needs. You may have business loans to be repaid. There may be capital needed to replace you as a key person in a business. There may be large amounts needed to cover death taxes. If your assets have to be sold to cover these expenses, your loved ones might have to accept less than what your assets were worth if they could have been held for sale during the normal course of business. An estate with insufficient liquid assets can be really hard hit. Liquidity needs can often be met best with liquidity insurance.
Rent or Buy Liquidity Insurance?
If the only purpose for the liquidity insurance is to make sure your big operating loan is repaid if you die during the next five years, then you can just rent the insurance. But most liquidity needs really don’t go away. If you would be successful enough to get the operating debt paid off in five years, you might develop an estate tax problem and then have another need, like taxes that would be due at death. So most people who need liquidity insurance should often end up buying it instead of renting it.
Theft insurance is a bunch of money needed to cover some theft from your loved ones from what you leave them when you die. The typical theft is the death tax. Many people in America meet this theft by buying theft insurance.
If you have something and think someone might steal it, you get theft insurance. If you know someone will steal from your loved ones, you should also get theft insurance. We live in a time when the federal estate tax is due to be phased out by ever increasing amounts that can pass exempt from tax, until the tax goes away. The current law may change, depending on what your government decides hereafter. Who knows whether your loved ones will need theft insurance? Maybe it would not hurt to have some.
Rent or Buy Theft Insurance?
In the past we knew for sure that theft insurance would have to be there, in place, when you die, even if you lived past normal life expectancy. Result: If you needed that type of insurance you had to buy it, not merely rent it. Now the need to buy instead of merely renting is more complex. But the best guess is that if your estate is of a size sufficient to produce death taxes, you should probably buy instead of merely rent the insurance. Also, if your estate is large enough to cause worries about death taxes, you have to acquire the theft insurance in a smart way to keep it from being taxed. Otherwise you have to acquire twice as much of the theft insurance.
Wealth Replacement Insurance
Many people of moderate wealth and nearly all with great wealth make current or delayed charitable gifts. You may find this idea appealing, especially as you get older. These gifts provide you with a wonderful choice of how to spend your social capital. Social capital is that part of your estate taken for income or estate taxes. Taxes you pay are your social capital that is spent in ways chosen by your elected politicians. Their ideas of social good may directly contradict your own views. You may have better ideas of how to spend that social capital.
Rent or Buy Wealth Replacement Insurance?
Wealth replacement insurance is designed to deliver the proceeds to your loved ones when you die at, or even after, life expectancy. So you should never rent this type of insurance. Instead, you have to buy wealth replacement insurance. And remember that the insurance you were considering when you were young, such as needs insurance, may end up being wealth replacement insurance when you are older. If that is the case the argument for buying instead of renting the needs insurance is stronger.
Call us for a consultation if you want more information on this topic.