In my recent encounters working with clients on their planning, we have uncovered a number of questions about insurance. The questions we typically hear are “How much do I need?”, “What kind of insurance should I buy?”, and “How do I know my insurance guy is selling me what I need?” Since it seems to be on the minds of many, let’s recap some of the insurance products out there and review the do’s and don’ts.
1. Survivor Needs
There are only two reasons to have life insurance. One is survivor need – how much your family needs if something happens to you. The other is to take care of estate taxes. Despite what life insurance agents tell you, life insurance is not usually a good investment.
To determine your survivor needs, add your current debt coverage to any planned future expenses (such as college for the kids). This determines your immediate need. Determine how much income your family needs to live on each year and add that to your immediate need. Subtract your liquid assets and the total equals your survivor needs. Then figure out the lump sum needed to generate that amount of cash on an annual basis. How long do you need life insurance? Until your current rate of savings equals your total survivor need.
Life insurance comes in two forms: term or permanent. Term insurance is the best buy for survivor needs because it costs less and is pure insurance. Permanent insurance allows you to build cash value, and it remains in effect as long as you pay the premium.
Permanent insurance can be either whole life, universal life or variable life. With whole life, the insurance company takes the risk on the investments and guarantees a certain rate of return. Thus, they base your premium on the expected rate of return. With variable life, you pick the investments and you take the risk. If your projections are wrong, you end up paying higher premiums. If you outperform projections, your policy will cost less.
If you only have survivor needs, buy term insurance. If you have a larger estate, buy permanent insurance to cover the tax liabilities when you die. The best approach involves “second-to-die” insurance, which doesn’t pay out until the second spouse dies which is when Uncle Sam brings the estate tax bill. We will touch more on this later in the year when we have a better direction as to what will be happening with estate taxes.
Lack of disability insurance is the landmine that can destroy all your financial planning. Your biggest asset is your ability to earn. Lose that and all your planning can be for naught. Disability is not just losing an arm or a leg. More often, it involves cancer, depression, back pain, heart problems and other debilitating diseases.
Disability insurance is generally cheaper through work because the risk is spread out amongst all employees. If you deduct your disability payments from your paycheck, you will pay income taxes on any proceeds you collect. If you don’t take the deduction, you don’t have to pay taxes on the proceeds. Most of the time, you’re better off taking the deduction now since your income would likely be lower if you were taking proceeds instead of drawing salary.
- Have a minimum of 120-day elimination period. You can afford to self-cover during that period and you will pay much less in premiums.
- Keep your policy only long enough to meet your needs. Don’t buy a lifetime policy if you only need coverage until age 62. Once your income producing days are over, your need for disability insurance goes to nil.
- Get a waiver of premium, which means you quit paying for the premium if you get disabled. Also, get an inflation rider, which means your coverage goes up with inflation.
- The best solution is to get disability insurance through work and augment it if necessary.
3. Long-term Care
Long-term care pays for a nursing home or in-home care. Many insurance companies are dropping this type of coverage because they are losing money on it. The average annual cost of long-term care is $82,000 for a private room in the Cincinnati area, and goes up about 5% a year, higher than inflation.
The emotional costs of long-term care are horrendous. Sixty-five percent of people rely on their families to care for them in old age. Many people miss work and even quit jobs to help take care of their parents. In many cases, you will take care of your parents longer then they took care of you.
Purchase long-term care insurance only if self-insuring isn’t an option. However, even if you’re financially independent, consider long-term care. For one, the market is so unpredictable. Two, it sends a message to your family that you don’t expect them to care for you. Persons with no desire to leave an estate may be alright to self-insure until the money runs out and then let Medicaid pick up the rest. Long-term care insurance is not cheap so if leaving an estate is not your desire, you might think twice before making that yearly premium payment.
When considering your purchase, be sure to look at whether you have indemnity versus reimbursement coverage. With indemnity, the insurance company gives you payout cash and doesn’t care how you spend it. With reimbursement, you submit expenses and get reimbursed. Indemnity is generally the more expensive of the two.
When purchasing long-term care insurance:
- Buy only from A‑rated companies.
- Look at the daily benefit amount. You may be able to self-insure for part of it, so that it doesn’t cost so much.
- Look for waiver of premium and home care options.
- Make sure the payout goes up to handle inflation.
For business owners, long-term care is fully deductible for C‑corporations, and you can discriminate, meaning you don’t have to pay for any other employees.
Medicare pays only for some advanced, specific hospital care for 100 days, not for long-term care. Medicaid pays long-term care, but only for the impoverished. When it comes to long-term care, you have three basic options
- Go broke.
- Insure for it.
- Have enough money to pay for it.
Pay attention to your parents. Unless you help them develop a plan, you are their long-term care plan.