By Dr. Jim Dahle, WCI Founder
The most important thing about term life insurance is to make sure you have a lot of it (seven figures) in place if anyone besides you depends on your income. If that is not the case for you, contact a WCI-approved agent TODAY and get this critical insurance in place.
However, it's worth taking a second to think about what should be done with that money in the unfortunate event that the policy should actually pay out. Thus, a reader question came in via email:
“I had an interesting conversation with my wife this morning, and we were left perplexed. We've been talking about life insurance and what would happen if I die tomorrow. We have a $3 million policy on me. My wife asked me, ‘So where should I put the money to make interest?' That's where I couldn't give her a good answer. I understand the basics—cover debts (of which we have none aside from mortgage), pay for college, etc. Once we get beyond that, where is the best/safest place to put the money so it generates interest without principal being at great risk? It will cover costs in part by the interest it generates, thereby making it last longer than if she had to just draw down the principal (which is how we had conceptualized it in our head originally).
In my readings, I've seen annuities (the life insurance company effectively acting like a savings account and generating interest). I also considered savings accounts, but there are potential issues with FDIC protection limits, and while the interest rates are relatively decent now, I remember just a year or two ago when even high yield savings accounts yielded only 0.5%. I've also seen recommendations for CDs and investing in all sorts of stuff (which comes with risk obviously). My goal is to make sure the money lasts a long, long time. This is a very different discussion now than it would be 20 years from now when my retirement accounts (which I have maxed out for a decade) are a lot larger than they are now. What should I tell her?”
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What Is the Plan?
When buying life insurance, you need a plan. What is the money supposed to do if the insured dies? Is it supposed to buy out the dead business partner's heirs so the remaining partners can carry on operations? Is it supposed to pay off the house? Is it supposed to cover a college education? Is it supposed to send the remaining spouse back to school for a few years so they can have higher earnings? Or, as is the case for most doctors married to stay-at-home spouses or low earners, is it supposed to ensure their financial life is exactly the same as it would be if the insured were still alive? Given the multi-million dollar policy, I suspect the goal is the latter.
More information here:
Preparing for Tragedy: Ensuring Your Partner Can Manage Without You
A Widow’s Financial Plan
Savings + Life Insurance Benefit = Nest Egg
There are two issues to bear in mind here.
First, you don't need an amount of life insurance equal to everything you will ever earn or even everything you will ever spend. As the emailer so astutely noted: over the long run, the money will grow in value due to interest, dividends, rents, and/or capital gains—just like any other pot of money.
Second, term life insurance simply makes up the difference between the amount already saved for retirement and the amount needed to live the rest of your life. Safe withdrawal rate studies suggest that a nest egg 25 times what you spend in a year will last 30 years with very high reliability. Truthfully, any sum of money that can last 30 years is awfully similar to the sum of money that would last indefinitely. In essence, your savings plus the death benefit simply needs to equal “your number.” If you need $5 million to retire today and have $1 million now, you need a $4 million term life policy.
Sample Plan
This doctor has been maxing out retirement accounts for 10 years. He is probably now a millionaire. Let's say he has $1 million saved toward a nest egg and estimates his “number” to be something like $3 million, especially if there is no mortgage and if college savings are not an issue. There is a $600,000 mortgage and he wants $100,000 in 529s for each of his four kids.
So, the first million of that $3 million death benefit goes to the mortgage and 529s. The other millions get invested in a taxable account. Between the taxable account and the retirement accounts, there is now $3 million and his wife can live the rest of her life on that.
More information here:
Is Whole Life Insurance Worth It?
How to Invest in Very Early Retirement
In essence, it's as though she retired very, very early. There is no Social Security or Medicare to help for many decades. Inflation will pop up from time to time during her 50-70 year retirement. She may want a little less aggressive asset allocation than was being used previously, but she will still need a substantial portion of the portfolio invested into risky assets such as stocks and real estate to keep up with inflation. It cannot all be put into CDs and savings accounts, and it should not all be put into an annuity, especially one that is not indexed to inflation. She has to take risk with the investments. Not taking those risks just isn't an option.
If she can earn some money from time to time over the next 30 or 40 years, that will allow her to spend even more. She will need to keep an eye on the portfolio and manage it carefully. If she is not capable of or interested in managing a multi-million dollar portfolio, she will need to hire an asset manager who offers good service and advice at a fair price. For the first few months (or even the first year), she should not make any major decisions or investments, just like someone who won the lottery. Meeting with a good financial planner is a great idea. Talking about how to manage money before she needs to do it on her own is also a great idea. This is one reason why managing money together is so important. If she remarries, a pre-nuptial agreement is mandatory.
Insurance benefit money spends exactly like saved money and earned money. There is no reason to think about it any differently.
What do you think? What is your spending and investing plan for life insurance proceeds should you or your spouse keel over? Comment below!
