Why Do You Have Insurance?

by | Jan 27, 2006 | Cash Flow, Weekly Column

Paul (not his real name) is in his 50’s, never married, with no children. His net worth is around $2,000,000, he has no debt, and his portfolio produces enough for him to live a comfortable lifestyle and pursue his interest in the geology of the Black Hills. Paul also has a "die broke" philosophy—if on the date of his death he finally spends his last nickel, his financial planning will have been a screaming success.

At one of our financial planning reviews, Paul took his seat in my office and said, "Well, I’ve got good news! I called a life insurance agent; I am going to update my policy and add another $100,000 to it."

"Well, you sound excited about that," I replied. "Tell me again, Paul, why do you have insurance?"

He stared at me as if I had just asked him why he needed to breathe. It was obvious he had never answered that question before.

After several seconds of silence, he said, "Well, I have it because everyone has it. I mean, everyone needs life insurance, right?"

His eyes opened a bit wider when I replied, "No, everyone doesn’t need life insurance, and you may be one who doesn’t."

The biggest reason people need life insurance is to replace their income earning potential. If the death of a person would not create an economic hardship on loved ones, partners, or creditors, then that person probably doesn’t need life insurance.

You typically need life insurance in the following situations:

  • You have minor children and your net worth is not sufficient to replace your income.
  • Your spouse relies on your income to support his or her lifestyle.
  • You have large mortgages or other indebtedness.
  • You wish to leave an estate to heirs or organizations that is larger than your actual estate.
  • You want to reduce the erosion of your estate by federal income taxes.

You typically don’t need life insurance if:

  • You are not married and don’t have any children.
  • Your spouse’s lifestyle or financial future would not suffer as the result of your death.
  • You have sufficient net worth to replace your income for the balance of your spouse’s life.
  • You couldn’t care less about leaving more than you have to heirs or organizations.
  • You have no large debts, or you have sufficient assets to pay off the debts and still fund heirs’ needs.
  • Your estate isn’t large enough to incur federal estate taxes or your “after tax” estate is sufficient to fund the needs of your heirs.

Clearly, Paul—with no spouse, no children, and no debts—had little need for insurance. He was relieved to know that, not only did he not need to obtain a new insurance policy, but he could cancel his old policy and go to Denver for the weekend on the savings.

How about you? Are you paying for insurance you don’t need? Or do you need insurance you don’t have? I probably run into far more people who need more insurance than those who don’t need it. My rule of thumb if you have children is that you should have a minimum of $500,000 to $1,000,000 of life insurance. You don’t need to mortgage your home to buy it, either. If you are in relatively good health, term insurance is typically inexpensive and adequate for most people.

The important thing is to ask yourself the question I asked Paul. Why do you have insurance? Don’t just assume you need life insurance. Instead, decide whether you need it after you consciously evaluate your particular situation.

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