Tailor life insurance so it provides income

Your Money

December 24, 2006|By Humberto Cruz | Humberto Cruz,Tribune Media Services

I know I'll receive a flood of reader mail whenever I write about hot-button issues such as Social Security. But I wasn't prepared for the avalanche from a recent column on the need for life insurance.The letters and e-mail, poignant and even angry, came from surviving spouses - usually women with small children - left to struggle financially because the main breadwinner did not have adequate life insurance, or any at all. And many of you, moved to act, wanted to know how much insurance to obtain and what type of policy is best.

As to the first question, I refuse to perpetuate the hackneyed rule of thumb of "x" times (I've seen anywhere from five to 10 times) your annual salary.

Rather, the answer must be personal, something like: "The right amount of life insurance will allow your dependents and beneficiaries to invest the insurance payout and then draw down the account over time in a way that matches the income you would provide if you were still around."

That's the rule I've always followed and the recommendation of the Financial Planning Association, the membership group for certified financial planners and other financial professionals in the United States, in its new book for consumers, The Encyclopedia of Financial Planning - What You Need to Know About Money From the Nation's Leading Financial Planners.

In other words, the focus is not just on a single number (the amount of insurance) but also on a strategy to invest and spend the insurance proceeds.

How to do it? You first estimate the amount of lost earnings if you die prematurely (so much a year in lost wages for the next "x" years, for instance, with the amount presumably going up to account for pay raises). Then, with a financial calculator, you estimate the present value of those future earnings, or how much money it would take today to generate the same future income stream.

You can play with the numbers (and increase or decrease the amount of insurance). For example, you may want enough insurance to pay for your children's college education in full even if the original plan was for them to apply for student loans.

Or you may conclude that at some point your survivors will be on their feet financially and will no longer need the insurance proceeds. Discuss all these factors with everyone affected and make a decision based on your needs, not a trite rule of thumb.

As to the type of insurance (the main ones are term or cash value), I cannot begin to cover the subject in such limited space. Term insurance (insurance that lasts a specific period or term, with no cash value or investment component), generally offers the highest death benefit for the premium dollars, particularly the younger you are.

A male 40-year-old nonsmoker, for example, can qualify for a 20-year, $500,000 term policy for $365 a year, said Byron Udell, founder and chief executive of AccuQuote, a leading online insurance broker.

Partly because of longer life expectancies but mostly because of intense competition in the industry (and the wide availability of services such as AccuQuote to compare rates) "term insurance rates are now 65 percent lower than they were 12 years ago," Udell said.

"Life insurance is not a fun product to buy," Udell said. "You would rather buy an iPod or a flat-panel TV. But with rates as low as they are, there is no excuse not to have it."

Yet one in three American adults has no life insurance and, among those who have it, one in three is covered only by a group policy at work, typically for an insufficient amount, based on 2006 figures by LIMRA International, an insurance and financial research organization.

So-called behavioral economics, a field that combines psychology and finance, helps explain why many people put off buying life insurance, said Bob Kerzner, president and chief executive officer of LIMRA.

For example, premature death is both unpleasant to think about and a low probability, so people tend to assume it won't happen to them. Buying life insurance can be complicated, and if the cost in time and effort of finding that information is perceived to be too high, people will put it off.

Also, people tend to think of insurance premiums as immediate "losses" and undervalue the possible future "gain" of a life insurance payment should they die prematurely.

And people usually are willing to spend only so much on insurance - their insurance account, as it were. They may focus mainly on home, auto and health, and - wrongfully concluding they can't afford more insurance - fail to adequately insure their lives.


Humberto Cruz writes for Tribune Media Services.

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