CPA’s Guide to Life Insurance
LIFE INSURANCE FUNDAMENTALS IN APPLICATION
Lance Wallach
1.2.0 Why Get Life Insurance?
1.2.1 Risk Management
Simply put, insurance is risk management—preparing for either the eventual or the unfortunate. Risk management is one of the more difficult compo-nets of the financial planning activity as it addresses the unknown, the intangible, and the unexpected—that which everyone expects will not happen. It is essential for the practitioner to guide the client in the ramifications of loss due to poor risk management. In most cases, the client will have made a much better attempt at risk management from a property and casualty component than that of their most valuable asset: themselves. Bear in mind that car insurance in many states is legally mandated, while other forms of insurance are optional. For many, it is easier to visualize a crushed fender or fire in the house than it is to accept the possibility of illness, disability, or death. Risk management is the first foundation to a well-constructed financial plan.
1.2.2 Role of Life Insurance in Retirement Planning
There are a number of reasons why life insurance can play an important role in the retirement planning process. First and foremost, the ability to provide immediate cash as a death benefit to the surviving family members brings CPA’s Guide to Life Insurance1-4
Peace of mind and financial stability during the period of asset accumulation. In addition, a cash value style of policy can assist in the asset accumulation objective. This can effectively offset the net cost of risk management over the period of years before and after retirement.
1.2.3 Benefits
Life insurance is unique in that it has congressional backing for benefits not available in any other financial product. Also, certain life insurance policies that are properly designed can offer a tax-free stream of income as a retirement supplement. This income stream is not taken into account for the purpose of qualifying the tax liability associated with Social Security benefits.
1.2.4 Purposes
Life insurance can be used for a variety of purposes:
.1 Create wealth—to protect and provide for spouse, children, or others who may be dependent on the insured.
.2 Preserve wealth—to provide immediate liquidity for the purpose of paying final expenses, estate taxes, and existing debt, so that accumulated assets can be retained for the benefit of heirs.
.3 Transfer wealth—to provide for charitable gifts in supporting organizations or a cause that was important to the insured.
.4 Estate taxes—properly structured, insurance can be removed from the decedent’s estate and used for liquidity or estate equalization.
.5 Immediate liquidity—certain policies, properly structured, can be used as a “bank account.”
.6 Tax-deferred asset accumulation—to fund or supplement college educational funding, collateral to start a business, purchase a vacation home, or provide for retirement.
1.3.0 Determination of Need
1.3.1 Areas of Need
There are three principal areas in which to calculate need.
.1 Income replacement and family capital Life Insurance Fundamentals in Application 1-5
.2 Business insurance needs
.3 Estate preservation and liquidity needs
1.3.2 Statistics
Most American adults are underinsured. Studies show that only about 43 percent own any individual life insurance outside of group coverage. Those who do own individual life insurance have only an average of $45,000 of coverage.
1.3.3 Techniques
.1 The practitioner may apply diverse techniques to determine the life insurance needs of a family. Any method of determining a family’s insurance needs will be an estimate since future circumstances may change in unexpected ways and basic assumptions about earnings, interest rates, inflation, and other associated factors may prove incorrect. Life insurance planning is best conducted with a comprehensive study of the client’s financial needs and concerns.
.2 The simplest methods to understand, although the least reliable, are the various rules of thumb that are frequently used to estimate either the amount of insurance that is needed, or the amount of expense to be allocated toward insurance premiums.
Life insurance is the only vehicle that can provide immediate cash to replace the loss of income that occurs when a wage earner dies. By replacing years of lost income, life insurance can assure the family that economic stability will prevail and that their lifestyle can be continued. Life insurance can also assure the completion of stated goals, such as the monies needed for college education, payment of mortgage, and retirement of a spouse.
The information provided herein is not intended as legal, accounting, financial or any type of advice for any specific individual or other entity. You should contact an appropriate professional for any such advice.