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How much Life Insurance should you own?
Saturday, 18 May 2013 13:49

One of the most fundamental questions about Life Insurance: How much? There's more than one answer.

There are several methods one can use to determine mathematically how much Life Insurance a person should own.

  • Human Life Value
  • Financial Needs Analysis
  • Capital Needs Anaylsis
  • Multiple of Income
  • Rule of Thumb

The most accurate method of determining how much Life Insurance a person needs is the Human Life Value approach. This analysis requires a complete set of client facts, and uses reasonable economic expectations to determine a numerical value of the human life based on one's ability to earn an income. The Human Life Value approach is the method most commonly used in a court of law. For example, when a court must determine financial damages in a wrongful death law suit, or how the 9/11 Victim Compensation Fund determined benefits to survivors.

Financial Needs Analysis is slightly less sophisticated approach than the Human Life Value. In a nutshell, one adds up their lump sum needs, such as paying off a home mortgage, other debts, funeral expenses, and adds to that total enough capital to replace the future earnings of the insured, using both principal and interest to provide this stream of income to beneficiaries. This method usually produces a lower need than Human Life Value, but often higher than any Rule of Thumb.

Capital Needs Analysis is only slightly different from Financial Needs Analysis. The real difference is that instead of using both principal and interest to replace income, capital is retained, and only interest income or growth of capital is used to provide income to beneficiaries. This method generally produces a larger needs than Financial Needs Analysis, and in some cases, may produce a need even larger than the Human Life Value approach. This approach is suitable for the Lifetime Net Saver or Wealth Builder.

A Multiple of Income approach to Life Insurance needs is relatively simple. This is the method that Life Insurance companies generally use for the financial underwriting aspect of risk assesment. In our experience, a Multiple of Income approach is acceptable for younger clients who have at the earliest stages of their career, but tends to be inaccurate for mature clients, who may have mixed families, with multiple layers of needs.

The method almost always used by journalists, under-qualified financial authors, radio show hosts, and life insurance critics is the Rule of Thumb approach. In our experience, this is the method most likely to produce sub-optimal results when a beneficiary needs money the most. This is why we believe that competent professional life insurance agents and prudent people avoid the Rule of Thumb approach.

Where all of these methods fall short is with the Business Owner and/or person subject to confiscatory Estate Taxes, Inheritance Taxes, and what we call the "Middle Class Estate Tax" -- the dreaded Income with Respect to Decedent (IRD) tax that often cuts IRAs, 401(k)s, and other tax-deferred retirement plans by a third to more than half.

This is where the professional Life Insurance Agent provides the greatest value, because the level of complexity with Business Life Insurance, Corporate Owned Life Insurance (COLI), Partnership Owned Life Insurance (POLI), Trust Owned Life Insurance (TOLI), and Bank Owned Life Insurance (BOLI) rises exponentially from the relatively simple problems associated with income replacement and final expense coverage for wage and salary workers.

If you want to work with a professional life insurance agent, then I would like to apply for the job. Call me today at (800) 680-5596, or click here.

 

Brent D. Gardner, CLU, ChFC