The key here is to understand what we need to protect, and that requires us to know what we’re spending.
Disability Insurance - How much?
For a household making $100,000, saving 20%, paying taxes with 30% and spending 50%, they would need to replace about $50,000 annually if they were to have their primary bread-winner be disabled and unable to work for a significant period of time. To simplify this process, most individual disability policies will replace 60% of your income. If it’s an individually owned policy and you are paying the premiums with after-tax dollars, then the monthly benefit comes to you tax-free, so the monthly budget is now protected.
That is a simple example and the reality is disability policies can be very complex. It’s important to consult an independent insurance advisor who is licensed with different insurance carriers, and is able to present and explain the many different intricacies of each contract.
Life Insurance - How much?
Life insurance is not too different. The goal is to provide financial means in the event of loss of a wage earner. There are two common ways to decide how much insurance to put in place; one is income replacement, and the other is liability pay down. While there is no right or wrong way to go about putting coverage in place, we’re going to focus on income replacement. In a similar exercise as discussed before, it’s important to decide how much monthly cash flow needs to be replaced.
Using the example above, let’s say we want to replace $50,000 per year. What amount of insurance would we need to be in-force to safely generate the cash flow back into the household? Using a 5% rate of return, which over a long period of time is reasonable for a balanced portfolio, we would need to put $1 million dollars of insurance in place. Similar to the tax treatment of disability insurance, life insurance proceeds are generally paid to the beneficiaries free of federal and state tax.
The reality is simple. Insurance, when used properly, is a very powerful financial tool.
The issue is, the way insurance is bought and sold. Insurance companies pay their agents’ commissions for selling their policies. Inherently there is nothing wrong with this, however this compensation structure can often drive an agent to be “pushy” and “over sell” the consumer which creates a frustrating and negative experience. Remember, though, not all agents are created equal, and it’s important to develop a relationship with someone you trust. Someone who will shoot you straight, explain the pros and cons of various policies and present you with several options from which you as the consumer can choose between.
As an independent firm, PFwise is that special someone, we can find the best insurance product for you!
Please feel free to contact us with any question on your mind.