Risk mitigation is one of the most important elements of a sound financial strategy.
While it’s important to accumulate wealth through asset appreciation, it won’t go far if there isn’t a complementary strategy in place to preserve assets and income. One of the easiest ways to protect income and assets against financial risk is to purchase a life insurance policy. For physicians, however, determining the right amount of insurance can be difficult. Instead of focusing on general rules of thumb, we suggest doctors and other high-income people assess two separate variables in their lives to get the most accurate number.
Variable 1: Lump sums
Lump sums are the largest, one-time payment expenses that the heirs and estate will face after the insured person dies. The first is the mortgage on the principal residence. Ensuring that the life insurance death benefit is sufficient to cover this debt is essential, especially when the insured leaves behind a spouse and children. The second lump sum payable on the death of an insured relates to other debts, including student loans, credit cards and car loans. The third is the amount needed for sickness and burial expenses.
David B. Mandell
Next, the insured should consider the future needs of their survivors and consider lump sums for tuition and mortgage balances on any investment property that generates income for the benefit of the surviving spouse. When considering the amount needed for future college tuition, it is important to think about the age of the children and how this will work for or against the ability to accumulate funds by investing.
While estate tax planning is an essential part of a larger financial planning discussion, it is important to note here that a lump sum can also be extremely valuable for the payment of estate taxes. , as the proceeds of the policy can eliminate the need for heirs to sell the estate. active quickly or at reduced values.
Variable 2: Annual income replacement
The second variable that high earners should consider is annual income replacement. When a surviving spouse and family depend on the insured’s income, their need to replace that income will continue long after the insured’s death. The difficult part of this for physicians, in particular, is to consider the range of income one could earn over the next 1, 2 or 3 decades and plan appropriately.
One of the easiest ways to determine how income and income needs might change is to divide life into three financial phases:
- The period before children are able to support themselves;
- The period after the children are independent, but before retirement; and
For example, someone who is now 40 years old could plan their next 50 years of income. To divide their future into the three stages above, they could allocate 15 years to the first period, 20 years to the second period and 15 years to the third period.
From there, the insured can determine income needs based on realistic lifestyle expenses for each phase. They can take into account some asset growth and must take into account taxes, as well as inflation.
Reassess old policies
Often it is thought that because a person took out a life insurance policy 10 years ago, they no longer need to think about protecting themselves. However, a lot can change in a decade. The death benefit needed in one phase of life is considerably more or less than that needed in another phase. Buying a bigger house or a more expensive car, sending kids to school, adding more kids to the family, changing your income or getting into debt can all affect the amount of insurance needed today, as well as in the adjusted future. Those who purchased life insurance years ago should ask more questions, including:
- Have income, debts or assets changed drastically?
- Have lifestyle expenses increased?
- How do college tuition fees compare?
- How long will the policy last and does it provide long enough coverage?
- Is the insured currently in the first, second or third phase of their life? What impact does this have on their family’s anticipated future financial needs?
Choose a policy
Once an individual determines a reasonable death benefit based on the assessment of the aforementioned two variables of lump sums and annual income replacement, the next step is to choose whether to fund it with permanent or term insurance. Both types of policies have advantages and disadvantages. When most of an insured’s needs focus on paying off debt and replacing a family’s income, term insurance is often the most appropriate choice.
Term insurance is a way to guarantee a fixed premium for a period ranging from 10 to 30 years. The younger the insured is when the contract is taken out, the lower the rate is likely to be. In some cases, it may even make sense to take out multiple term policies for different time periods to reduce death benefits as debts and other financial obligations diminish.
Following the general rules of life insurance can be helpful for some. However, the more a person earns, the less “general” their needs are. For physicians and other high-income individuals, it is more realistic to consider their particular financial situation and the likely changes they will see during the three phases of their financial lives. This offers them a better chance of obtaining the appropriate amount of life insurance coverage.
Choosing the amount and type of life insurance death benefit and class of policy are important considerations for any doctor. Working with an experienced advisor is key to evaluating options and making informed decisions.
Wealth planning for the modern physician and Wealth management made easy are available for free in print or as an e-book download by texting HEALIO at 844-418-1212 or at www.ojmbookstore.com. Enter code HEALIO at checkout.
For more information:
Sanjeev Bhatia, MD, is an orthopedic sports medicine surgeon who practices at Northwestern Medicine in Warrenville, Illinois. He can be contacted at [email protected] or @DrBhatiaOrtho. David B. Mandell, JD, MBA, is a lawyer and founder of the wealth management company OJM Group www.ojmgroup.com. You should seek professional tax and legal advice before implementing any strategy described here. He can be reached at [email protected] or 877-656-4362.