There are a lot of dangers to your financial plan. It could be an unexpected accident that sets your budget off course. It could be not saving enough for retirement. It could be [insert presidential candidate you dislike] winning the election and throws economic forces into chaos.
But what if the biggest danger is just not living long enough to see any of this actually happen?
What’s the biggest risk to your financial plan? MarketWatch mentions shortfall risk, the possibility that “you won’t have enough money to make your goals.” CNN Money talks about investment risk, which you’re probably familiar with; CNN defines it as “the extent to which an investment’s price or returns bounce up and down.” Take a look in the newspaper and you might find a million other political risks: Brexit, for example, or a feeling of unease over who might be elected in the fall.
All investments – whether it’s for retirement, a college savings plan, or in your home – require time. The concept of “compounding,” whether it be in compound interest or compound gains from your investment, is based entirely around how much time you have to invest. That’s why most financial experts suggest that you start investing as soon as possible – usually by age 25.
“If you’re saving for retirement, there are really only three things that can happen to your savings,” says Brian Grimes, CFP, one of our Senior Client Services Managers here at PolicyGenius. “You either end up with more money than you put in, less money than you put in, or about the same amount. But all three of these outcomes operate under the assumption that you don’t pass away prematurely.”
You might be thinking that that’s a little depressing, but stick with me.
Dying prematurely is not only emotionally devastating to your family, but it’s financially devastating as well, touching on every major aspect of your financial plan. It’s a simple fact that, if you die, your income will no longer be available to your family. You probably already know this, but it’s worth repeating: your income is a crucial part of your personal and family budget, which is the foundation of your family’s financial plan.
Your income and family budget directly feed into two other major pillars of your financial plan: long-term financing (mortgage, car loan) and investments (college savings, retirement, estate planning). “The purpose of financial planning, at its purest level, is to generate a plan that will grow a nest egg of money that you can use to pay off all of your debt obligations and support you indefinitely without you having to work,” says Grimes. If you die prematurely, you won’t be able to fulfill that main objective of financial planning.
If you die at any point before your financial plan is complete – whether that be saving for retirement, college, paying off a big debt like a mortgage, or some combination of all three plus other goals and obligations – those goals remain incomplete. Your family will need to find another way to complete your financial plan without your income. “If you die young, your family is potentially losing your peak earning working years – your forties, your fifties,” says Grimes.
The backup plan for your financial goals
Insurance is an important and often forgotten component of your financial plan that’s just as crucial as your investments or mortgage.
You probably already have insurance – health insurance, car insurance, etc. – but there’s only one type of insurance that protects your family in the event that you die: life insurance.
Life insurance can be a very simple product. For pure protection, you’re going to want to look specifically at term life insurance. The other major type of life insurance – called permanent life insurance – is an entirely different beast. The most common type of permanent life insurance, whole life insurance, attempts to be both a savings or investment vehicle and an insurance product. While this is useful for some consumers with high incomes and more complicated financial plans, it’s not the best solution for most Americans who just need affordable life insurance.
Term life insurance, on the other hand, is often referred to as “pure” life insurance because, like other insurance products, it has a single objective: protect against a high-impact risk. Unlike permanent life insurance, term life insurance lasts for a specific “term” of time, typically for ten, twenty, or thirty years. You pay a monthly premium – $500,000 of coverage for a twenty-year term will cost around $30 per month for a healthy male in their mid-30s – and, in return, your survivors will receive a tax-free lump sum of money if you die during the term.
This lump sum of money can be used for anything, but for most families, it’s intended to act as a backup for your financial goals. Let’s walk through an example.
Say you’re saving up for your daughter’s college education. You’ve been saving for two years now, but you estimate you still have another sixteen years to go until you have enough to cover her entire college tuition. You buy a life insurance policy with enough coverage that your spouse will be able to fill up the savings account if you die. You sign the papers and then you die the next day. Thanks to the life insurance policy, your spouse can complete your financial goal, despite your death and the loss of those crucial working years.
Brian Grimes calls life insurance a “self-completing financial product.” Why? Because you get that full amount no matter when during the policy you pass away. It does not require time to build up, unlike your retirement or college savings goals. “There’s no other financial product that does this,” Grimes says.
According to Grimes, using life insurance this way specifically protects the “accumulation phase” of your financial plan. That’s the period before you’ve finished your retirement savings, when you’re still working and accumulating wealth. This is another reason that using term life insurance makes sense – you buy it for a period of time when the risk of not completing your financial goals is the highest and you stop paying for it once you no longer need that safety net.
But life insurance isn’t just used to complete savings or investments; it can also be used to protect your family from debt. Mortgages are one of the longest and most expensive debts that a family will take on, and many families need two incomes to pay off a mortgage and not feel stressed about it. Amelia Tyagi, co-author of The Two-Income Trap, told Mother Jones that “[w]e tend to assume families with two incomes [are] doubly secure. But if you count on every penny of both of those incomes, which most families today do, then you’re in big trouble if either income goes away.”
Luckily, life insurance can take care of mortgages in much the same way it takes care of savings goals.
We’ve talked to a lot of people who are confused about the true nature of life insurance. Part of that has to do with the name – people may understand that life insurance pays out a benefit if they die, but they may not make the connection as to why.
So think of it this way: the same way that car insurance is a safety net for your car, home insurance is a safety net for your home, or health insurance is a safety net for your health, life insurance is a safety net for your financial plan. It’s the easiest, cheapest, and best way to mitigate the risk that you won’t have time to complete your financial plan.