Life Insurance For Parents

On 9/11 two families I knew from my swim club lost their husband/father. There aren’t enough adjectives to describe the emotions we all felt not only for those poor, young families. There was, however, also a sense that many of us (the members) dodged a bullet, for it could have been any one of us who lost a family member. I remember telling my wife, shortly after 9/11, that I was just sitting in a seminar in the towers two weeks before. My friend had a 9 a.m. business meeting in the towers the week before. Another friend had to cancel a meeting on 9/11 for personal reasons. Any one of us could have been “them”.

So where are these struggling families now? Every summer I still see them at the swim club. The kids are getting bigger. They run around with my kids and my friends’ kids, smiling and laughing and living. I see the mothers at various little parties at the Tikki Bar, drinking and laughing and living.

Their lives are certainly different. Their Dads are missing from the picture. But there they are living the same lifestyle they had before 9/11.

How is this possible? Life insurance. Each of the fathers was smart. Very smart. Why? They believed in life insurance. They were not like most people who see life insurance as an expense, a product to be sold to them by some aggressive, commission-seeking life insurance agent. The see life insurance for what it really is, a deferred asset. These two, smart, husbands and fathers were not satisfied with the meager life insurance their employers provided. They sat down with an insurance professional and, together, determined how much life insurance they needed in order for their families to live the same exact lifestyle in the event of their death.

This isn’t an illustration, this is reality. When someone dies the thought that races through the minds of many individuals is that it won’t happen to me. It only happens to the other person. Well to me you are the other person. People die. Fathers die. Mothers die. It happens every day of every week of every month. When one of the individual’s who dies is a breadwinner the effects upon the family are compounded if there is not adequate life insurance. If you are a parent and you don’t have adequate life insurance you are being negligent and uncaring. Life insurance is a must have for all parents.

How much is enough? As a financial professional I use the following formula to determine how much is enough for my clients:

Gross annual compensation lost as a result of death divided by 5%

Example: Joe and Jean Smart are married with three small kids. Joe makes $ 80,000 a year and Jean makes $ 20,000, working part time. Joe has $ 200,000 in life insurance provided to him by his employer. Jean has none. Both come to see me to find out how much life insurance they need. I go through the above formula: $ 80,000 divided by 5% = $ 1,600,000 minus $ 200,000 = $ 1,400,000. If Jean dies, the family will need $ 400,000 to replace her lost wages.

Why the 5%? If you were to invest Joe’s $ 1,600,000 into a relatively conservative investment that generates 5% interest it will produce $ 80,000 of income. If you were to invest Jean’s $ 400,000 into the same investment it will generate $ 20,000 in income. Financially, the family is secure.

Some may look at this simple illustration and argue that they could cut their insurance need in half and use some of the principle. Well, if you did that, in 14 years you would be out of money. What if you reduce your need to $ 1 million, and use the principle? In 20 years you would be out of money. You see, there is no way of making the case for using the principle to fund your lifestyle if you plan on living for a long time. Eventually you will run out of money. The only way to insure your financial future is to determine how much income you need to replace and obtain an amount of insurance to help fund an investment to generate the income you need.

There are two types of insurance: Term and Permanent. Term insurance is pure insurance. You pay for the death benefit and that is all. Term expires every year and must be renewed every year. Term is the cheapest type of insurance available. Permanent insurance is a combination of death benefit and investment. The premiums are higher and the reason for this is that part of the premium is used to create some type of investment return, known as cash surrender value. This cash surrender value builds up over time and can be used to pay the premiums down the road. Thus, it is permanent. Which type should you own? In my opinion everyone should have a combination of term insurance and permanent insurance. The term coverage should represent about 70-75% of your total insurance coverage and the permanent the rest. The reason for this is that as you get closer to retirement age, term will be too expensive to maintain any longer. The permanent insurance cash surrender value can then be used to help provide some supplemental income in the form of borrowing from your built-up cash surrender value, which would be tax free. As you get closer to your retirement years your insurance needs are reduced and the permanent insurance will be there to provide some death benefit for your spouse as well as some supplemental income.

If you have young kids you have an adult responsibility to provide your family with adequate life insurance. It is hard enough on the family, psychologically, when a spouse/parent dies. Don’t compound it by further burdening them with financial trauma as well. There is no smooth transition when a loved one is lost, but compounding that loss with the need to sell the home, move into a cheaper neighborhood, uproot the children, just exacerbates the situation. Do the right thing and do it today. Get to an insurance agent and find out how much you need. Listen to them and do not challenge them. They are the professionals. They are there to help. Be a smart and caring parent!

Tom is a Certified Public Accountant, a Certified Financial Planner, CLTC (Certified Long-Term Care) and President of Cerefice & Company, the largest CPA firm in Rahway, New Jersey. Tom works with clients helping them manage their money, retirement planning, college savings, life insurance needs, IRAs and qualified plan rollovers with an eye towards maximizing tax benefits and minimizing taxes. Tom is founder of the Rich Habits Institute and author of “Rich Habits”.

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