Welcome to Hidden Value, the column where Joe Elsasser, CFP, answers common questions with insights advisors and their clients may not have considered.
QUESTION: My client has multiple life insurance policies. How do I determine what he really needs?
JOE ELSASSER: If life insurance has not been a part of your practice or you’ve been disappointed by the performance of life insurance strategies you’ve seen implemented in the past, consider the possibility that the policy itself wasn’t the perfect fit for the job.
Working with retirees to get their finances in order, it’s fairly common to come across clients who have accumulated multiple life insurance policies throughout the course of their careers. Many of these clients bought their first life insurance plan when their first child was born and bought a couple more as their personal economic circumstances changed. Life insurance, like any other insurance, is neither bad nor good. It exists to protect people from a certain risk or to deliver a specific economic advantage. How do you determine which policies to keep, add, sell or lapse? Advising which type of policy and what amounts are appropriate should be based on the ability to meet the client’s needs.
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There are two basic rules to life insurance:
- Don’t risk what you can’t afford to lose
- Don’t buy more than you need
The key is identifying the client’s precise risk mitigation need or desired economic advantage, and then determining whether the existing policy or policies meet that need. Life insurance products can effectively address several issues, including income replacement, liquidity at death, increased certainty of inheritance, and supplemental retirement income.
Income replacement Here’s an example of how life insurance can help a retiree who needs income replacement. Consider a client who has pensions from several past employers and elected the “single life” option on all of them, with the expectation that he would outlive his wife. Although their relative health and family history would suggest that’s not a bad expectation, it’s not certain. When shown what his wife’s living standard would be in the event of his death, he quickly recognized that some element of protection made sense. Determining how much is simply a matter of projecting the shortfall she would face in the absence of his pensions, after accounting for the fact that the cost to run the household will be less with only one mouth to feed. Consider a minimum premium universal life policy with a no-lapse guarantee. That structure will keep the premium costs as low as possible while maintaining the ability to meet the need at death. Term riders can also be effective.
Avoiding liquidating assets at death Another client owns and operates a midsize soybean farm and has two adult children. One child wants to run the farm and the other wants no part of it. In the event the client dies, there’s not enough cash in the business to buy out the disinterested child. Life insurance could provide liquidity at precisely the right time. This is one example, but there are many situations where liquidity at death is extremely important to allow estate equalization without liquidating assets. In this situation the need is specific at death, so carrying significant cash value through the life of the policy doesn’t add value.