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This year, it doesn’t seem necessary for Life Insurance Awareness Month to remind us of just how precious life is. Our thoughts and prayers are with the people of Texas, Florida, Oregon and Montana as they work to rebuild the destruction caused by hurricane and fire. To the men and women who have come to the aid of others, whether by way of professional duty or just human compassion, we thank you.
The recent natural disasters highlight the importance of preparing your family financially, should the unexpected occur. Life insurance pays a tax-free death benefit to a named beneficiary following the death of the insured. If there is anyone in your life who depends on you financially, then you should have life insurance for as long as you will be depended on. This goes for the household breadwinner as well as the stay-at-home parent making it possible for a spouse to work. In addition to replacing lost income or the cost to replace stay-at-home care, insurance can be used to pay off existing debts, or provide for other financial goals and priorities, such as college.
For young families, we recommend having enough life insurance that the investment growth alone could replace your after-tax income.
For example , if your after-tax income is $75,000, assuming a 5% investment return, $1.5 million of insurance will be sufficient ($1.5 million x 5% = $75,000). While the result might seem to overestimate the need, the coverage should yield an amount that will maintain your family’s lifestyle and provide a cushion for unexpected expenses or lower-than-expected investment performance. Given its low cost, this coverage is likely to be term insurance for the number of years until retirement.
Capital Preservation Method After-Tax Income Need / 5%
Income Replacement Calculation Insurance Need
$50,000 / 5% = $1 million
$100,000 / 5% = $2 million
$200,000 / 5% = $4 million
$300,000 / 5% = $6 million
For families nearing retirement, the need for life insurance may decrease as the number of income-producing years becomes smaller. Multiplying the number of years you expect to work by your annual after-tax income should provide enough coverage to allow your survivors to cover both expenses and savings until retirement. Keep in mind that this may fall short if your death would cause a loss in one or more retirement income sources (think: pension).
Related: Frequent Misses in Coverage for Auto and Homeowners Insurance
Ultimately, to determine your unique insurance needs, we recommend working with your financial advisor .
Making $ense of Hindsight Bias
Studied in behavioral finance , hindsight bias is the tendency for individuals to over-simplify the predictability of an event, once the event has actually occurred. Investment decisions are often made with hindsight bias whereby investors attempt to predict cause and effect based on past events. Studies suggest that such decisions have not proven beneficial over the long-term.