Do I need insurance at 45? How about 65? The answer is – It depends…
Let’s be honest. Insurance is a boring topic. Very few people want to ponder what would happen if something went wrong. Many people say, “That won’t happen to me,” or “I’ll worry about that later.” Those who do want to tackle these tough questions are often unsure of how much insurance they need. Working with a financial planner can help bring clarity to a cumbersome but important process.
Insurance is simply paying a premium to transfer risk from you to an insurance company. While home and auto are the most common coverages people acquire, it is important to consider other risks to your financial picture. Life, disability, and long-term care are the topics we will discuss in this article. The correct answer for how much of each type of coverage you need is dependent upon your own unique circumstances at that time.
Perspective is helpful. It is human nature to decide to take a short cut and arrive at the simplest, fastest answer when making decisions. That topic is explored in more detail in a book called “Thinking, Fast and Slow” by Daniel Kahneman, a book I highly recommend. Humans want to exert the least amount of brain power to quickly find the “good enough” answer and move on. This type of fast thinking can leave gaps and exposure that could harm you and your family.
Consider two different couples, one age 45 and one age 65. It may be logical to understand they have different insurance needs because they are in different stages of their lives.
Let’s cover life insurance first and look at our 45-year-old couple. They have two children, ages 12 and 10. They are a single income household. What type and amount of insurance do they need?
A useful acronym to get the conversation started is L-I-F-E. It stands for: Liabilities, Income, Final Expenses, and Education.
Liabilities – The 45-year-old couple has a mortgage. If either of them died prematurely, a life insurance death benefit could pay off the mortgage, removing a financial burden on the surviving loved one and ensuring they aren't forced to relocate. Other items such as auto loans or consumer debt are added when considering liabilities.
Income – We need to consider lost wages in our calculation. This is a single income household with a spouse and two school-age children. How many years of income are expected until normal retirement? Can the non-working spouse find employment if necessary? Many factors must be considered, and income is often the largest component of the total.
Final Expenses – Funerals can be a large expense, and harder to deal with when a grieving spouse must figure out how to fund it. Life insurance is a logical way to cover this expense.
Education – What does education look like for the two children? This is difficult to predict, and the current cost of four years of college can vary wildly. It is prudent to assume a higher cost for four years of college for both kids and add that to our total.
Those four categories combined give you an idea of how much life insurance you will want. For most, this is a larger number than they initially expected they would need. At age 45, you have the expectation of your life to live and your goals to accomplish.
Now let's consider the same L-I-F-E exercise with our 65-year-old couple. They are retired, empty nesters. If we go through that same exercise, we come up with a completely different total. Their liabilities are likely lower or nonexistent. Income replacement is not as relevant since they are retired. Final expenses may be important, but perhaps they have significant assets that could be used to cover an expensive funeral. Education is now not applicable because the children are grown. At this stage, their life insurance needs are lower or even gone completely.
The next item to look at is disability and long-term care insurance. These are not to be confused with health insurance. Disability insurance is an income replacement. Long-term care covers a host of services not covered by health insurance, including Medicare.
Given their current familial situation, the 45-year-old couple is more apt to look at disability insurance than long-term care insurance at this phase of life. Disability insurance will help cover the working spouse's income to ensure expenses are still covered if they are unable to work. The goal here is to get the benefit to come as close as possible to the net income that they currently receive. Since the 65-year-old couple is retired, disability insurance is of no need to them.
Long-term care is potentially relevant to both couples as they look to the future, though it is much more relevant to the 65-year-old couple. They will be faced with important decisions such as where to live and whether to choose some form of assisted living with a progressive care model. Costs can vary greatly depending on the location and types of services rendered. Some have saved enough to cover this expense, while others have not. Ultimately, long-term care insurance can serve to protect assets you intend to leave to loved ones.
While everyone’s financial situation and goals are different, these examples do illustrate some of the important factors that must be considered when determining your insurance needs. Let a fiduciary financial planner help you consider the myriad of variables and factors to come up with the right decision for you.
Financial Enhancement Group is an SEC Registered Investment Advisor.
