Making the Most of Life Insurance

Andrew Busa:

Is there someone in your life who depends on you financially? Listen to this episode to hear our take on how to tackle risk management as part of your financial plan.

Andrew Busa:

Hi, this is Andrew Busa, manager of financial planning at Adviser Investments. And we’re here with another The Adviser You Can Talk To Podcast. Today, I’m joined by my colleague Adrian Baldeon. He is a member of Adviser’s financial planning team. Adrian, welcome.

Adrian Baldeon:

Hey, Andrew, it’s great to be here. Thanks for having me on.

Andrew Busa:

This is your first podcast. This is big right here.

Adrian Baldeon:

Yes, it is, absolutely. Happy to be here.

Andrew Busa:

Okay, good. So today we are talking about risk management, which is basically a fancy way of saying we’re talking about life insurance today. So, we’ll be focusing on really two pieces: Term life and whole life. But we promise that we’ll make it exciting. And Adrian is… You’re a former life and health insurance producer, so this is a great topic to have you aboard for since you’re the expert here.

Adrian Baldeon:

Yeah, that’s right. And I think it’s important to note “former insurance agent,” as we here at Adviser do not sell insurance. But we do regularly review and recommend all types of risk management tools when working with families on constructing their financial plans. And purchasing insurance on your life or your loved one’s life in case you die can be a lot like buying a plunger. You don’t buy one hoping that you’ll one day get to use it. But should the need ever arise for one and you don’t have one that works, then you or your family might find themselves in a rather unpleasant situation.

Andrew Busa:

Okay. I’m going to remember that analogy. Life insurance is the plunger of your financial plan, basically.

Adrian Baldeon:

Yes, exactly.

Andrew Busa:

But that’s what we’re talking about here—risk management. How do you manage the risk that’s present in your financial plan? And insurance is how you do that. Life insurance is one specific slice of risk management, but this is an important enough topic that we need to dedicate an entire episode to talking about it. It’s not often thought of as a specific goal when we talk to a client about owning a certain amount of life insurance. But that’s why we’re here as planners, to sort of prompt and bring up these sorts of topics with clients.

Andrew Busa:

So today, we’ll cover three things: Number one, the basics of life insurance—how it works, how much coverage you should get. Number two, the broad differences between term and whole life, how to think about that. And then finally, which one is right for you—also in the context of some high-level client examples that we’ll talk through that you might sort relate to and see yourself in.

Adrian Baldeon:

Yeah, exactly. And we’ll dive into a few scenarios for different stages in life, like early career, retirement and legacy. Keep in mind that every family’s situation is unique and we’re happy to talk to you about your specific circumstances. But we’ll give examples of the more common situations that we encounter in creating financial plans.

Andrew Busa:

That sounds good to me. But before we get to that, we have to cover some basic terminology. Adrian, help us understand: What are the basics? What do we need to know?

Adrian Baldeon:

The main purpose of life insurance is not for the person that dies but for the people that survive. So, you buy it to protect your family from someone dying too soon. The premiums are paid in exchange for a death benefit or payout at passing. And naturally, a lot of us first start thinking about life insurance when we get our first job, we get married, have children or other major life events. So it’s really when we feel that added sense of responsibility to protect our loved ones.

Andrew Busa:

And that’s spoken like a new dad. Congratulations, by the way, on that.

Adrian Baldeon:

Thank you, Andrew. I haven’t been getting a ton of sleep as of late, but I like to think that I rest a bit easier knowing that there is that safety net in place.

Andrew Busa:

Right? Those are the things that often are the catalyst for needing insurance because you have more risks to cover. A simple question that you can ask yourself is: “Is there somebody in my life that depends economically on me?” If the answer to that is yes, you probably need life insurance. If the answer is no, you might not just yet, but this is still important information to be aware of.

Andrew Busa:

So let’s say yes, you do need life insurance. How do you actually determine how much you need? Because you mentioned there’s a death benefit involved. So, that’s the amount that gets paid out to the survivors. How do you determine what that death benefit should be for the policy you’re shopping for?

Adrian Baldeon:

So the basic framework for the amount of death benefit needed is actually an acronym of the word LIFE.

Andrew Busa:

Good. I won’t forget that, then.

Adrian Baldeon:

Yeah. No, it’s pretty convenient. And LIFE stands for liabilities, income replacement, final expenses and education costs. So the L for liabilities—we’re calculating those by adding up your family’s existing debts. So next, we’ll talk about I for income replacement, which can be trickier. There’s a bit of complexity there. As a rule of thumb, you can multiply your current income by the number of working years that you want the insurance to cover. And 10 years is a good starting point. Then we have F for final expenses, which include funeral costs and legal fees necessary to settle your estate. And lastly, the E is education costs, which will include college tuition or maybe private school fees for your children.

Andrew Busa:

So adding up those four numbers, L-I-F-E, will help you determine the amount of life insurance that you need to ensure that your beneficiaries won’t have any financial worries if you were to pass away prematurely.

Adrian Baldeon:

Exactly. So after you’ve determined how much you need, you’ll then have to go and find out how much it will cost. And there are two main types of policies: Term and whole life.

Andrew Busa:

Okay. So that brings us right to talking about the difference between these two things: Term life insurance and whole life policies. These are the main types of life insurance. You might also hear it as permanent life insurance or temporary life insurance. Talk to us about this a little bit.

Adrian Baldeon:

So, term life insurance covers you for a set period, maybe 10, 20, 30 years. Whole life insurance will cover you forever as long as you pay that premium.

Andrew Busa:

So, term life—basically think of this as renting. Whereas whole life, you’re owning. You’re in it forever. Term is going to expire at a certain point.

Adrian Baldeon:

Yes, and whole life is much more expensive. And we’re talking around 10, 15 times more than term life for an equal amount of death benefit, but it comes with extra features like the cash value account, which also earns tax-deferred interest.

Andrew Busa:

So, I’m thinking about this. When would you choose one over the other? How do you actually determine which is right for you?

Adrian Baldeon:

Yeah. So the first thing you would need to determine is if the need is temporary or permanent. And remember, we’re talking about risk management, so we’re going to transfer that risk over to the insurance company. And with term life, it’s usually more appropriate for most people because of that affordability and the amount of coverage that’s accessible. And you tend to have less of a need of coverage as you progress throughout life and coverage in your retirement years.

Andrew Busa:

Right. Remember, we mentioned that L-I-F-E acronym before. You can use that as a guideline, no matter where you are in your life, to determine how much you need. And like you said, Adrian, those four numbers will probably get less as you get older, as your stage in life changes.

Adrian Baldeon:

Exactly. And whole life can be more complex and can be used as another way to invest outside of traditional accounts.

Andrew Busa:

And another thing to note here is flexibility. You can cancel a term policy without penalty at any time. Whole life policies could have penalties that apply when it comes to canceling coverage. Read the fine print, talk to your agent about that. But I think the key thing of what you said there is, again, determining if your risk need is temporary, or is it permanent? And we’ll get into a couple of examples of where you might see a more permanent risk management need arise in a financial plan, where whole life could be more appropriate. I know you had a couple of other points here, too, on the tax ramifications.

Adrian Baldeon:

Yeah. So, there are only two certainties in life (sometimes life insurance): Death and taxes. And life insurance death benefit payouts are usually tax-free. But sometimes, if maybe the policy’s payout causes your estate’s worth to exceed this $12 million threshold, your heirs might be charged estate taxes. And also, maybe your beneficiaries will pay taxes, should they choose to receive a payout in installments where there’s maybe a third party involved, and the taxes will be on that earned interest. And the last thing to kind of note there, or to be aware of, is your state may levy some inheritance taxes, depending on where you live.

Andrew Busa:

I think here, too, it’s important to talk to your attorney. Make sure that they’re in the loop with regard to… As you’re making your estate plan, ensure that they’re aware of what life insurance policies you own so they can make a full determination on what your estate tax liability might be. But again, as you said, death benefit—typically that’s going to be tax-free for the survivors.

Andrew Busa:

Yeah, I guess my key takeaway from this section here is that you need to determine if your risk is temporary. And term life is going to be appropriate for most people. Whereas whole life does provide permanent coverage and it gives you a cash value, like you said, Adrian. And there’s some use to that. But oftentimes, your additional dollars that you’re spending on whole life insurance are probably going to be better used in the market, just historically.

Andrew Busa:

So, all right. We’ve covered the basics. We’ve talked about how much insurance it makes sense to get. We’ve talked about the difference between whole life and term life. Let’s get into some general client profiles and examples here.

Andrew Busa:

The four that we wanted to cover are this idea of a wealth accumulator, someone younger; someone who’s a pre-retiree; someone who’s retired; and then finally, someone who’s thinking about legacy and that next generation. So start us off, Adrian. What are you thinking about a 35-year-old client who comes through the door when you’re assessing their life insurance need?

Adrian Baldeon:

So usually you’re early on in your career, you may have some group life benefits, maybe you have a family. You’re in that wealth accumulation phase, and there’s a lot of time to cover there, so your need may actually be higher. And so you’re working and you’re saving. Your salary probably hasn’t peaked. There’s a lot of years left. So most commonly, we’ll see term life used in these scenarios because of that higher death benefit need and also affordability. And there are some scenarios where maybe there’s a high-income earner who’s maxed out their retirement accounts, HSAs and those avenues. And maybe they’re looking for more tax-deferred growth, and they may be looking toward those whole life policies as well.

Andrew Busa:

Got it. And I think for these folks, the life insurance need is probably as high as it’s ever going to be. Right? Because if you think about that—again, going back to that L-I-F-E methodology—your income replacement need is very, very high at this point. As you mentioned, Adrian, there’s a lot of working years left between now and retirement. So if you were to pass away prematurely, that’s a very large financial benefit that you’d be missing out on, or your survivors would be missing out on, more accurately.

Andrew Busa:

Okay. How about the pre-retiree? So, we’re fast-forwarding. Let’s say you have that person who buys a 25-year term policy. And they’re coming up and they’ve got a few years left on it. They’re fast-forwarding, they’re in their 50s. I think the most common question we get from this group of people is: “What do I do with my policy that I bought 20 years ago?”

Adrian Baldeon:

Yeah. So often we see people approaching retirement wondering if they should let their policy lapse. A couple things to revisit are the needs, if they’ve changed, their health, and other family circumstances that may have changed since purchasing the original policy. And also maybe the opportunity cost of paying the higher premiums for insurance vs. investing those premiums more traditionally.

Andrew Busa:

There’s a lot of planning that can be done. I think in this age group that comes up because as you’re approaching retirement, yes, your need for life insurance is probably dropping. But you might want to continue a policy for a certain period of time. So, have you run across that sort of idea with clients? I’m curious about that.

Adrian Baldeon:

Yeah, certainly. So, they can essentially continue that coverage without going through underwriting, but maybe with a reduced death benefit.

Andrew Busa:

Right, because your death benefit, theoretically, doesn’t need to be as big anymore, as your need diminishes as you get older. So now let’s talk about someone who’s retired. How do you have that? How does that risk management conversation shift with someone in this bucket?

Adrian Baldeon:

Yeah. When you retire, you may lose your employer-provided life insurance plan. So, you’ll start investigating plans on your own. And having your own policy in place is a good idea if you have debt like an outstanding mortgage or you have a spouse or any dependents that rely on you financially. And so the conversation may shift from that income replacement/death benefit need to maybe other types of insurance, like long-term care.

Andrew Busa:

So it’s sort of taking a big-picture view of your risk management need and going through that financial planning process. It’s really helpful to do that. And keep in mind, too, I guess it sounds obvious to say, but as you get older, life insurance is going to get more expensive because your life expectancy is getting less. Right? So as you get older, it’s going to be a lot more expensive to go out and buy a policy.

Adrian Baldeon:

Exactly.

Andrew Busa:

And then last one here, this is… We could spend an entire series of episodes on legacy planning. But the use of life insurance within this category is really interesting, actually. And I know you have some points here that you wanted to share.

Adrian Baldeon:

Yeah. So the big thing that we kind of come across when considering life insurance and legacy planning and estate planning is typically for higher-net-worth individuals who have sizable estates. And you can keep your life insurance death benefit from being counted as part of your estate by taking that policy and transferring the ownership to an irrevocable life insurance trust, also known as an ILIT. And you pay those premiums out of the trust account. And this will put the policy and the payout under the trust’s control, so it’ll be excluded from the value of your estate.

Andrew Busa:

All right. And there’s complexity here when it comes to an ILIT, or an irrevocable life insurance trust. But what we’re talking about here when you’re thinking about legacy planning from a life insurance standpoint—it’s all about estate taxes and creating an estate plan that’s efficient for you and for your beneficiary. So life insurance can absolutely be a part of that; it just needs to be done the right way. And this is where, oftentimes, we see whole life or permanent policies factor in because they can be used for estate liquidity, things like that.

Adrian Baldeon:

Exactly. So with ILITs, the rules are complex and must be followed to the letter. To prevent your policy from being brought back into the estate, it’s worth working with an adviser to set up the trust correctly. For example, the three-year rule states a policy is still part of your estate if a transfer of ownership occurs within three years of your death. So, little caveats like that.

Adrian Baldeon:

Another thing to note: As it stands, the estate-tax exemption is set to increase for inflation through 2025. And then in 2026, it sunsets, or it’ll revert back to a lower level. And this is something Congress can adjust at any time. So, another thing to consider in your estate planning,

Andrew Busa:

Yep. I like it. Let’s wrap up with some key takeaways before we leave the listeners. Do you want to start off with anything that you’d like to share?

Adrian Baldeon:

Yeah. Typically, term life is right for you if you want an affordable way to leave a death benefit behind to financially support your loved ones and if you maybe expect to self-insure in the future. Then whole life might be right for you if you want to minimize your estate tax or you want to build cash value or you have some long-term dependents.

Andrew Busa:

Yeah. I think those are good ones. Your expertise was definitely much appreciated throughout this episode.

Andrew Busa:

The key takeaway I think for me is that risk management is a critical part of everybody’s financial plan. And it’s going to differ depending on where you are in your life, your different circumstances. That will help us give you a recommendation for what sort of life insurance you need to make sure that all your risk holes are covered. It’s not the most fun topic, we know that. But it’s maybe the most important one that we talk about with our clients.

Andrew Busa:

So, this has been Andrew Busa and Adrian Baldeon from Adviser Investments, thanking you for listening to The Adviser You Can Talk To Podcast. If you enjoyed our conversation, please subscribe and review our show. And you can also check us out at www.adviserinvestments.com/podcast. Your feedback is always welcomed. And if you have questions or topics that you’d like us to explore, please email us at info@adviserinvestments.com. Thanks for listening.