An adequate amount of life insurance protects income, assets
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One of the most important components of a sound financial strategy is to mitigate risk.
Although accumulating wealth through asset appreciation is important, it will not go far if there is not a complementary strategy in place to preserve assets and income. One of the simplest ways to protect income and assets of the physician’s estate against financial risks is to purchase a life insurance policy. Determining the right amount of insurance can be challenging. We suggest physicians and other high-income earners evaluate two distinct variables in their lives to get the most accurate number.
Variable 1: Lump sums
Lump sums are the larger, single-payment expenses that heirs and the estate will face once the insured dies. The first is the mortgage on the primary home. Ensuring life insurance death benefit is enough to cover this debt is critical, especially when the insured leaves behind a spouse and children. The second lump sum to be paid out upon an insured’s death is other debts, including student loans, credit cards and auto loans. The third is the amount necessary for illness and burial expenses.
Next, the insured needs to consider the future needs of his or her survivors and consider lump sums for college tuition costs and mortgage balances on any investment properties that generate an income benefiting the surviving spouse. When considering the amount necessary for future college tuition costs, it is important to think about the age of the children and how that will work for or against the ability to accumulate funds through investing.
While estate tax planning is an essential part of a larger financial planning discussion, it is important to note here that a lump sum can also be extremely valuable for the payment of estate taxes, as the policy proceeds can eliminate the need for heirs to sell estate assets quickly or at reduced values.
Variable 2: Income replacement
The second variable high-income earners should consider is annual income replacement. When a surviving spouse and family rely on the insured’s income, their need to replace that income will continue long after the policyholder has died. The difficult part of this for physicians, especially, is accounting for the range of income that one might earn during the next 1, 2 or 3 decades and planning for that appropriately.
Source: Sanjeev Bhatia, MD; and David B. Mandell, JD, MBA
One of the simplest ways to determine how income and income needs might change is to divide life into three financial phases:
- the period before children are able to support themselves;
- the period after children are self-supporting, but before retirement; and
- retirement.
For example, individuals who are now aged 40 years might plan for a future 50 years of income. To divide their future into the above three stages, they might allocate 15 years to the first period, 20 years to the second period and 15 years to the third period.
From there, the insured can determine the income needs based on realistic lifestyle expenses for each phase. They may factor in some growth of assets and should consider taxes, as well as inflation.
Reevaluate old policies
Often, it is thought that because someone bought a life insurance policy 10 years ago, that person no longer needs to think about securing coverage. However, a lot can change during a decade. The death benefit needed during one phase of life is drastically higher or lower than the one needed during another phase. Buying a larger home or more expensive car, sending kids off to school, adding more children to the family, changing your income or taking on debt can all impact the amount of insurance needed today, as well as in the adjusted future. Those who purchased life insurance coverage years ago should ask more questions, which include:
- Have income, debt or assets drastically changed?
- Have lifestyle expenses increased?
- How do college tuition costs compare to what these have been?
- How long will the policy last and does it provide coverage for a long enough period of time?
- Is the insured currently in the first, second or third phase of life? How does that impact the family’s anticipated future financial needs?
Choosing a policy
Once an individual determines a reasonable death benefit based on evaluating the aforementioned two variables of lump sums and annual income replacement, the next step is to choose to fund it with either permanent or term insurance. Both types of policies have advantages and disadvantages. A permanent life insurance policy increases the cash value over time. However, permanent life policies typically require higher premiums than term policies, because there is a savings element (the cash value), in addition to the death benefit coverage. If the goal is to purchase the most death benefit during a period of time for a given premium amount, term insurance is typically selected. When most of an insured’s needs focus around paying off debt and providing a family with income replacement, term insurance is often the most appropriate choice.
Term insurance is a way to guarantee a fixed premium for a period anywhere from 10 to 30 years. The younger the insured is when taking out the policy, the lower the rate is likely to be. In some cases, it can even make sense to purchase multiple term policies for different periods of time to help reduce death benefits as debts and other financial obligations decrease.
Conclusion
Following general rules of thumb for life insurance can be helpful for some. However, the more a person earns, the less “general” that person’s needs are. For physicians and other high-income earners, it is more realistic to consider their specific financial situation and the likely changes they will see during the three phases of their financial life. Doing so offers them a better chance to secure the appropriate amount of life insurance coverage.
Choosing the amount and type of life insurance death benefit and category of policy are important considerations for any physician. Working with an experienced advisor is essential for evaluating options and making informed decisions.
- Reference:
- Wealth Planning for the Modern Physician and Wealth Management Made Simple are available free in print or by ebook download by texting OT22 to 844-418-1212 or at www.ojmbookstore.com. Enter code OT22 at checkout.
- For more information:
- Sanjeev Bhatia, MD, is an orthopedic sports medicine surgeon practicing at Northwestern Medicine in Warrenville, Illinois. He can be reached at sanjeevbhatia1@gmail.com or @DrBhatiaOrtho.
- David B. Mandell, JD, MBA, is an attorney and founder of the wealth management firm OJM Group www.ojmgroup.com. You should seek professional tax and legal advice before implementing any strategy discussed herein. He can be reached at mandell@ojmgroup.com or 877-656-4362.
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