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How much life insurance do you really need?
By Evelyn R. Fine |

LIFE INSURANCE. Without its modern corporate connotations, one would imagine an elixir of the gods or the fountain of youth. Who wouldn’tpay a small fortune to be guaranteed one’s existence? But unfortunately, life insurance is not that. Rather, it’s the promise of a death payment.

Death payment. Doesn’t sound nice at all, does it? To the nastiness of mortality, add the reputed greasy charm of the insurance salesperson and the greed of large corporations. It’s little wonder that so few of us really know if we need insurance or not, how much to purchase or how to get the most for our dollars.

It’s not hard to decide whether or not you need insurance. Answer these two questions: Is anyone totally or largely dependent on your earned income for his/her financial survival? Can the dependent(s) find another source of sufficient income if you die?

If there is no one surviving you who requires a death payment, you don’t need life insurance. Singles, childless two-career couples, children, the independently wealthy and comfortable retirees probably need no insurance at all. Still, those people without dependents might well be told by a salesperson to buy now. Why? Well, they say, you might need it later, at which point you might be uninsurable. In truth, only about 3 percent of individuals of all ages are considered uninsurable-and many or them have had disqualifying physical problems since birth or have genetic predispositions to certain diseases. If you’re young and healthy, with a healthy family, it’s unlikely that you will become uninsurable in the next few years. True, some ailments may occur that can cause your insurance rates to rise, but you will still be able to purchase insurance-and you will have saved years of premiums. Don’t buy insurance you don’t need at age 25 just to be able to have it at age 35.

If you’re wealthy, you’ll be advised to cover estate taxes with an insurance policy. This insurance probably isn’t necessary. Taxes are not levied when a spouse inherits from a spouse. They are levied only when your children or others inherit, and, by 1987, they’ll be levied only on estates worth more than $600,000. If you will be leaving* more than that after you and your spouse are gone, be sure to consult a good attorney. There are a variety of estate tax shelter devices available to you (or you may decide that an estate of $600,000 can cover the taxes itself).

Unless your children have the earning power of Michael Jackson or Brooke Shields and give you a generous allowance, they do not need to be insured.

You do need insurance now, if by dying today you leave a husband, wife, child, parent or other dependents without sufficient financial support (assuming, of course, that you care about what happens to them when you’re gone. Not everybody does!)

WHAT AMOUNT OF life insurance provides sufficient support? Agents and other advisors frequently use five or six times earnings as a rule of thumb. While this may give a good estimate, it’s wise to take a close look at your complete personal financial situation in order to get a reliable figure.

The most accurate estimate involves a detailed accounting of your assets and liabilities. Ideally, you’d like to leave behind (in insurance, savings, investments, pension funds and social security benefits) enough money to pay for your funeral, to support your spouse above and beyond his or her current income, to raise your kids and send them to college, to help out your ailing mom and dad, etc. Let’s start adding: $5,000 for your funeral; half a year’s salary for an emergency fund; four years of college tuition at maybe $40,000 per child; and living expenses for the lifetime of your survivors.

Living expenses are simple to analyze for the next few years. It’s whatever the family spends of your earnings minus your personal expenses. (Some advise using 75 percent of your income, which frequently results in the same amount.) But who knows how much a Big Mac might cost in the year 2000? Ways to index for inflation are too numerous and detailed to enumerate here, but one easy method is to ask yourself how well your investments do after taxes and inflation, then insure your survivors for a lump sum that can be invested to yield their living expenses each year. If, for example, you earn 10 percent on a tax-free investment during a time of 5 percent inflation, you’re earning 5 percent after inflation.

If your family needs an additional $30,000 a year to live (over and above your spouse’s income, Social Security payments and other benefits), they need to have a “pot” of $600,000 that would earn 5 percent after taxes and inflation to generate it and conserve enough to cover next year’s inflation. In theory, this “pot” remains untouched; only the interest is used for support. In reality, of course, the “pot” can be used and liquidated slowly at some later point-say, after the surviving spouse’s retirement.

Add the one-time expenses to the support “pot,” and you have a gigantic figure that can keep your dreams and family going indefinitely. Subtract from this your current savings, pension accumulations and existing life insurance (from a group policy with your company, for example), and the resulting figure is more or less what you need to buy. This figure should be adjusted downward if: your spouse may be earning significantly more in the future than he/she is currently; your survivors plan to sell a number of less liquid assets-a second home, car, boat, small business, etc.; substantial aid can be counted on from other sources (wealthy and generous grandparents, for example); the lifestyle of your survivors could be downgraded somewhat without excessive hardship. The figure could be adjusted upward if there is a likelihood of your spouse earning less in the future, if you’re extremely worried about inflation or if you’re concerned that the survivor’s lifestyle would be too Spartan as budgeted.

This adjusted figure should be your personal guide to the amount of life insurance you need. Don’t buy more or less from anyone without asking a lot of questions. But be forewarned: Estimates will vary wildly. In researching this column, I did the type of analysis described above on a hypothetical couple (joint income of $70,000, with one child) and decided that they needed about $400,000 of total death income coverage for the higher wage-earner, with $50,000 for the lower. Consultation with two different agents resulted in one recommendation of only $300,000 (an extra $150,000 policy in addition to the current one held) and $30,000, and another for $540,000 and $180,000! The latter figures were the result of an analysis that omitted Social Security for uncertain reasons. It came nestled in 11 oversized pages of computer printouts that projected even larger sums of money back and forth over time. While computers are useful for looking at the numbers of the future, their accuracy depends on assumptions that are frequently hard to make. Be extremely wary of the overkill inherent in someone handing you stacks of incomprehensible data, especially if they recommend a purchase nearly double from what you yourself estimated.

YOU FEEL BETTER now, don’t you? You know how much to buy. But beware! Here’s where the “sales” in an insurance salesperson can really get you. What kind of policy do you need?

There are two basic types of life insurance policies, but they have several guises. One is called term insurance, and it’s the simplest to understand.

Insurance companies are bet-makers. They know that on the average, 1.7 out of 1,000 35-year-old, non-smoking men will die each year. They want each of these men to bet against their own death. Live, you lose; die, you win. Fun, isn’t it?

They will charge every 35-year-old enough to cover the big payout to the 1.7 in 1,000 who die, while making some nice profits for themselves.

You pay a premium each year to be insured for a given period of time (the term) for a given amount of face value. If, when the term of your policy expires, you want more insurance, then you buy it for another term. Term insurance is very inexpensive for young people, since they aren’t likely to die. Each subsequent year, term insurance costs a little more than the last, since you are statistically one year closer to death. By the time you are around 60, term insurance is quite expensive. When you’re 80, the cost is virtually prohibitive.

The other type of insurance combines insurance benefits with an investment feature that creates a so-called cash value. This type of policy is generally considered permanent insurance, and it comes in the general form of either whole-life or a universal-type (an adaptable, interest-sensitive) policy. For young people, these policies cost a great deal more than term insurance but the rates stay the same over a lifetime-so you pay much less when you’re older. Some of the overpayments in the earlier years go toward building your cash value-a part of your policy that earns interest for you at a given rate. The cash value is yours in the sense that if you cancel your policy, you can take it with you. The cash value is somewhat yours in the sense that if you need the money but still want to have your insurance policy, you can borrow your cash value and pay interest (generally low) on the loan. The cash value isn’t yours at all in that if you die, you only receive the face value of the policy (minus any outstanding loans), not the face value plus cash value. (A few plans have you overpay premiums by so much for so long that you begin to own your cash value. These plans are complex and very expensive.)

Until recently, the only permanent policies available were whole-life policies. These built up cash value very slowly and at very low (sometimes negative) interest rates. As interest rates and consumer awareness rose during the Seventies, many people began to borrow these cash values and invest them on their own. Other people only bought term insurance and left no cash values with the insurance companies. “Buying term and investing the difference” became the smart-money motto. The insurance companies, not wanting to lose these sums of money (they like investing and earning interest on the money themselves; they make lots of profit on the interest on yourmoney), devised the newer universal and interest-sensitive policies, which pay a higher rate of return when interest rates are high, although the guaranteed return is only 4 percent.

Although these universal-type plans offer more than the old life policies did, that doesn’t mean they offer enough to warrant buying one. An insurance salesperson will proudly announce the current rate of 10 to 12 percent interest paid on these policies. What you won’t be told is 10 to 12 percent of what. Your cash value is surely not the entire difference between the cost of term insurance and the universal premiums you pay. For example, the $150,000 policy recommended by the agent mentioned previously was offered in either term or a universal policy. The universal policy required payments of $827 per year and was presented in a spiffy computer print-out illustrating its 12-percent return, which, after 20 years, provides an accumulated value of more than $17,000. Yet it only takes $240 per year over 20 years at 12 percent to grow into $17,000. Where did the other $600 go? Not to your investment! And not solely to insurance either, since term was offered at less than $200 per year to start. To be sure, the term premiums go up each year, but on a good policy it won’t even go up to $820 in the 20th year. As compared to the universal policy, a good term policy with an “invest the difference” fund led to a nest egg of more than $50,000 in 20 years.

With either term or universal, the policy pays $150,000 upon your death. If you live, you’ll have more cash available to you with a term insurance plan. Invest it wisely for your future, and you’ll need less insurance as you grow older-possibly none by retirement. With universal, you have a forced savings account that is a very mediocre investment. Don’t let a salesperson tell you otherwise or scare you into fears of losing your policy.

A renewable term policy keeps you from being uninsurable for a specified period of time. Don’t be humiliated into thinking of yourself as a mere “renter” of term insurance, as opposed to the more reputable “ownership” and “equity-building” of permanent insurance. Nor should you be cowed into thinking that you’re not disciplined enough to save without the help of your insurance policy.

A good agent should be able to get you low-cost term insurance. Since term insurance can cost a lot or a little depending on the company, you should shop around for an agent who handles several insurance companies.

There are approximately 400 insurance companies that are rated “A+” or “A” by Best.the industry reviewer. All these companies should be reasonably financially secure.

Since term life insurance is for a limited period of time, you should shop around every few years for a better deal. Suggested rates should be less than $200 per year for a $100,000 insurance policy for men at age 35. (Consumers Union published ratings for hundreds of policies in 1980. Although your policy may be different, their guide would give you an idea of what price to search for.)

You should review your insurance needs every few years as your lamily and financial situation changes. Another reason to purchase term insurance is that you might not always need insurance, or you might need different amounts at different times. Remember, you must have dependents without resources in order to need different amounts at different times. Children grow up, investments flourish, spouses get rich- and suddenly you don’t need any insurance at all.

If you need life insurance, buy it as terminsurance and get a low price. If you needmoney for the future, save it and invest it. Ifyou have money to invest, talk to a banker ora broker.

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