Dave Sather writes a column about financial issues for the Victoria Advocate.

Dave Sather

Dave Sather

Mike and Paige called needing assistance. Mike works offshore as a self-employed consultant while Paige was busy raising their 3-year-old and 6-year-old sons. Paige was concerned about how they would manage their finances if something bad happened to Mike.

A million questions swirled in Paige’s head. How would they deal with the mortgage? How would they deal with the car notes? How would they get the kids through college?

As Paige did research, she was equally confused by the overwhelming number of insurance products. Variable, universal, whole life and term insurance were all foreign concepts. What term to get? What is cash value? What is the investment component?

These are the types of questions facing most young families. Despite the complexity and confusion, the simpler the answer, the better the outcome.

In visiting with Mike and Paige, we started by asking them to fill out a Net Worth Statement. List out your assets and liabilities and the specifics on your liabilities. For the young couple, their debts amounted to $275,000.

However, that did not consider that if Mike died, Paige would need a job or help around the house. There was also the obligation for the kids.

In a situation like this, we look for maximum “bang for the buck.” Term insurance is by far the most efficient way of hedging the risk associated with an income earner passing away. We explained to Paige that term insurance is approximately 1/10 the cost of whole life or other products having a “cash value” component.

Mike was unsure of the idea as he liked the thought of building “cash value.” Unfortunately, if you run the math on most cash value products they really function as a very expensive money market fund. More importantly, the goal of life insurance is to replace the economic benefits provided by an earner. It is not an investment. View it strictly from a risk-hedging perspective.

Paige liked the fact that term life insurance rates are highly efficient. Furthermore, it allowed the couple to be more strategic in terms of matching the risk against the time frame of the policy.

A term policy has a set coverage period – anywhere from one to 30 years. When it reaches the end of that term, the policyholder decides to renew it or not.

In Mike and Paige’s particular case they recognized they had at least 20 years of obligations associated with raising and educating the kids. Furthermore, their new mortgage had 27 years remaining.

As such, it was easy enough to round up to needing 30 years of coverage. The next question was, “How much to get?”

Obviously, there are $275,000 of overt debts to deal with. There is also the issue of funding education for the kids. There were also considerations associated with replacing Mike’s income.

People are often surprised when our recommendations start at $1 million of coverage. Furthermore, we suggested coverage on Paige’s life too. Although Paige might not have a formal “income,” she provides an invaluable service to the family. If Paige died unexpectedly, Mike would need additional help around the house, tutoring the kids, driving the kids to school, shopping and cooking, among other tasks.

After running through this simple analysis, the young couple recognized the need to hedge their risks over the next 30 years. After 30 years, their mortgage should be paid off and the kids would be off the payroll.

Mike recognized that replacing his income would be significant. As such, they bound coverage for $1.5 million on Mike’s life. At the same time, they secured coverage of $750,000 on Paige’s life.

This allowed the young couple to deal with truly catastrophic issues — at least from a financial perspective.

A local insurance agent or an online life insurance calculator can help you address these needs. Youth and health are also factors in how much insurance you can afford or obtain. As such, getting coverage while you are young and healthy makes the endeavor more efficient.

It’s important to work with financially healthy carriers that will be able to honor their obligations 20 or 30 years from now. Look for strong ratings from Standard & Poor’s, A.M. Best or Fitch.

Finally, don’t buy insurance and forget about it. Review your insurance purchases every few years as part of your overall financial plan. Life circumstances change — incomes rise and fall and family size changes. Your insurance holdings need to reflect current needs and conditions.

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Dave Sather is a Certified Financial Planner and the president of the Sather Financial Group, a “fee-only” investment and strategic planning firm. His column, Money Matters, publishes every other week.

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