Disability & Life Insurance: Foundations Of Protection Planning
April 21, 2022
To grow in any area of life—be it sports, music, your business, or something else—you must address your areas of weakness. If you don’t, they can become obstacles that make you stumble later, no matter how strong you are in other areas.
This principle is especially true of financial planning. Even when you accumulate significant wealth, you leave the door open for loss and failure if you don’t identify your risks and protect the assets you already have.
That’s why protection strategies are essential to the financial planning process. Without them, you have a weak foundation upon which to build your success. In this blog, we’ll talk about two key protection strategies and the difference they can make in achieving your financial goals.
Risk management is all about preparing for the worst-case scenario. When you look at your finances, ask yourself, “What’s the biggest risk that could negatively impact my future goals?”
If you’re young and have years of earning potential ahead of you, that devastating risk is likely not a dip in the stock market—it’s losing your ability to work for the next 20 or 30 years.
That’s why a long-term disability plan is so valuable—the insurance helps replace a meaningful part of your income if you get injured and can no longer work. And the younger you are, the more important that is for your long-term goals.
It’s also important to know what kind of disability insurance you need to maintain your desired lifestyle. Social Security benefits often include disability benefits, but these typically don’t provide enough income. Long-term disability insurance, on the other hand, is designed to help replace the majority of your after-tax income if you can no longer work.
Not all long-term policies are created equal, though. After all, the definition of “able to work” varies greatly. If you work in a specialized profession—say you’re an attorney or a veterinarian—and you become injured but still have the ability to flip burgers, then a general long-term disability policy won’t pay out benefits—because, technically, you can still work.
But if you opt for what’s called own-occupation insurance, those benefits will pay out as long as you can no longer work in your current occupation. These policies can also be specialty specific—for example, if you’re a surgeon who gets injured and can’t perform surgery but can still practice medicine, you would still receive your benefits. Or you could opt for residual coverage that helps bridge the gap—so you might continue to work in the medical field (just not in surgery), and your insurance would pay the difference in your income.
As you can see, the type of coverage you might need depends on your personal situation, but the important thing is to address the possibility that you might lose your ability to work—and plan for it.
As the name implies, life insurance provides benefits to your beneficiaries in the event of your death. Those benefits can serve several purposes:
Pay Off Debts
If you have outstanding debt, your family might be responsible for paying it off when you pass away. Life insurance can help cover that.
Cover Future Income
If you’re the breadwinner (or co-earner) of your household and you pass away unexpectedly, life insurance benefits can replace the lost income for your family.
Fund Future Goals
In addition to supporting your current lifestyle, your income might also fund future goals like paying for your children’s college. When you purchase life insurance, you can factor in that goal to the amount of coverage you want for your family.
Minimize Your Tax Burden
If your estate is above the estate-tax exemption threshold, you might consider purchasing a life insurance policy that helps cover your estate taxes. For example, if your estate is $10 million above the threshold, that means your estate could owe roughly $4 million (40%) in taxes upon your death (in addition to any state estate taxes, if applicable). If you’d prefer the entirety of your estate go to your beneficiaries (and not Uncle Sam), you can purchase a $4 million life insurance policy outside of your estate (making it estate- and income-tax free) and use it to pay the taxes.
So exactly how much life insurance do you need? Just like with disability insurance, the amount and type of coverage you need depends on your situation and goals. You might have heard the rule that you need ten times your gross salary, but that’s not always the case. Instead of looking at your income, look at what you spend and what your family needs to live on—that’s the number you’re looking to replace. If you make a great living but spend frugally, you may need less coverage. That’s why it’s important to look at the numbers and determine a plan that suits your situation.
The Essential Conversation
When you’re preparing for your future and putting together a financial plan, you need to ask yourself three questions:
- Where do I stand financially?
- Where do I want to be in the future?
- What could get in the way of me achieving my goals?
The answer to this third question is the first step in building a strong financial future. It helps you recognize risk and determine the kind of protection strategies you might need.
That said (and despite what other professionals may tell you), not everyone needs disability or life insurance. You might be in a situation where losing your ability to work isn’t catastrophic to your lifestyle or financial goals—say, if your family is financially able and willing to support you if you were to become disabled. Additionally, if you and your spouse both work, but you could each reasonably live on only one income stream, then a substantial life insurance policy may not be necessary.
These protection strategies aren’t crucial for everyone, but the planning is. You have to have the tough conversations and ask yourself, “What would happen if?” And, after discussing potential scenarios, if you determine you don’t need life insurance or disability insurance, great—just make sure you know why. Make it a conscious decision to forgo those strategies, and then create a plan for the unexpected.
But Wait, There’s More
Life insurance and disability insurance are just two planning strategies that help protect you from risk and further your goals. To truly maximize your resources, you’ll need to ask yourself intentional questions about the future and consider multiple aspects of your financial situation.