Allow me to begin this article with a story of why I sell life insurance. Early in my career I met several times with a young couple in their early thirties with 3 young children to determine their need for life insurance. We landed on $138,000 and wrote a policy which was then rated higher than expected due to health concerns. The insured was uncertain they wanted to pay the higher cost, but after some conversation agreed to go with the policy. Three months later we got “The call”, the wife had died suddenly leaving the husband with 3 young children to raise. We paid the claim; the insured paid off his home, invested $50,000 and raised his three children, two of whom went on to excel at local high school sports. This is the why of what I do. When purchasing life insurance there are a number of things to consider in determining the correct amount. Many “Experts” state that you should simply purchase a multiple of your annual income. However, I beg to differ with the experts, I have found that the best way to determine the needed amount of life insurance is to customize your own needs. For the business owner, I would recommend exploring a buy sell agreement. This is an agreement between two parties that at the death of one party, the other would purchase your business or your share in a business for an amount of money agreed upon in advance. A legal agreement would be drawn up by an attorney to solidify the deal. However, the best way and the way most buy sell agreements are funded are through life insurance. Let me walk you through an example: Partner A and B own a business together valued at $1,000,000. Both agree to buy the others share for $500,000 in event of death. They go to an attorney to draw up the legal agreement. The next question is (neither party has $500,000 in cash) where do the funds come from to complete the deal? Partner A would take out a life policy on B for $500,000 and B would do likewise for A, thus in event of death, the funds are available to buy out the others share of the business. Another way to achieve this based upon whether or not your business is an LLC or corporation is to have the corporation purchase the insurance. You would need to see your CPA for the ramifications. A major reason you would want this type of agreement is if you don’t have one in effect, you could effectively be placed in a position at the death of your partner that you are now by default in business with their spouse or other family members that have no desire to be in your business, but want their share of the revenues and profits. Thus having such an agreement in place and fully funded by life insurance is a very proactive and smart move. As far as your individual life insurance needs, you could use this simple needs analysis below.
- How much would I need for burial
- What are the most out of pocket medical expenses I would be obligated to pay in event of a prolonged illness prior to death, i.e., what is my medical calendar year deductible, and maximum out of pocket medical expenses?
- What debts do I want paid off in event of death, i.e., credit cards, car payments, student loans, etc.
- What is the balance of my mortgage principal?
- If I have dependent children, how much would it take to educate them based on today’s costs? The idea here is if you have enough today, the money could be invested to keep up with inflation until the children are ready for college.
- How much do you want to leave to your favorite charity?
- The final consideration would be income replacement as my income dies with me, yet the bills keep coming.
- With all of the other needs taken care of, how much of my current annual income would my surviving family need to live off without touching the principal: This is called wealth preservation. An example would be I want to leave my family $25,000 annually, I must determine what is a reasonable rate of return on a large investment, let’s assume 4%, Divide $25,000 by .04% = $625,000. This number at 4% interest would produce $25,000 in annual income without touching the principal. Note, when considering how much income to leave your family, you can consider social security benefits if you qualify. An agent should be able to assist you with this.
- Finally you must look at your current life insurance and other assets and subtract them from your needs to determine your true need.
- Final Expenses- $12,000
- Out of pocket medical expense – $8,000
- Debts to be paid off – $125,000
- Mortgage balance payoff- $225,000
- Education of children – $60,000 x 2 children = $120,000
- Money left to charity – $100,000
- Income replacement- $625,000
- Total Need = $1,215,000
- Current savings, retirement plans, and other assets= $350,000
- Final need is = $865,000
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