Should we cancel our life insurance and invest the contributions instead?
I noticed you were talking about having no debt and all your purchases are in cash. You also talked about substantial investments and savings. I want to commend you for that – you have stuck to the basic tenet of financial planning, which is to minimize debt and focus on investing as early as possible.
Where you invest is less important (don’t read not important, read less important) than when you actually start investing. Those who start investing early in life have the advantage of taking advantage of the power of compound interest. They will need to invest less over time than those who are slow to invest, and their cash flow will not be strained later in life.
Generally, one starts his career and a family with a limited heritage. During the early phases of one’s professional career, the debt is higher than later in life due to home loans, car financing, baby expenses, education expenses, etc. During these times, the need for life insurance peaks.
As the investment portfolio gains structure and value, the need for life insurance decreases.
There are exceptions where insurance requirements may be very high later in life, such as when a business is purchased or expanded, and life insurance is required as collateral, but I will not elaborate on these specific requirements for now.
Before buying or canceling life insurance, you need to determine what you need the insurance for and how much you need. Let’s explore some reasons why one should have life or should I say capital insurance. Life insurance is only required to cover the lack of capital you have to meet certain demands or “wishes”. There are many circumstances to consider when choosing life insurance. The following items come to mind, but the list can go on and on:
- Provide capital to your surviving family in the event of your death. If the breadwinner dies, their spouse and children need funding to maintain their standard of living and cover day-to-day expenses.
- If a person loses their ability to earn an income due to injury or illness, capital is needed to replace their income either temporarily or permanently. In this case, the capital can be either a lump sum insured or a monthly payment by the insurer.
- In the event of death, various expenses become payable, for example:
- Settle debts i.e. bonds, vehicles, overdrafts, credit cards, etc. ;
- Pay inheritance tax; and
- Executor fees.
Where there is insufficient capital (liquidity) available for service charges in a patient’s estate, assets will be sold to cover the costs. Life insurance can play a vital role in preventing the unwanted or forced sale of assets within the estate.
So the main question is how much life insurance is needed, if any?
Earlier, I spoke of life insurance as available capital and that is exactly how it should be considered. What we have to accept is that life insurance is a grudge purchase. Very few people wake up in the morning and scream while stretching, “Today I’m going to buy life insurance, yay!”
Life insurance must therefore be justifiable and measurable, otherwise it risks being terminated as soon as cash constraints arise. Everyone should therefore also know exactly what the implications will be when deciding to terminate life insurance.
Interestingly, the average person would rather insure their car and household goods than their own life. When asked why, they indicate whether they are the victims of an accident or theft. My question is always, what are the chances of you being in an accident or losing your car to theft? And what are your chances of dying….? I think the odds favor life insurance as a potential claim.
My colleagues know that my view on financial planning is simple: it’s all about income.
Life insurance is no different from investing. The only difference is that by investing, the planner benefits from the fruits of the investment. With life/death coverage, the survivor(s) of the deceased benefit.
Why do I say planning is about income? It’s simple. The income requirement under all circumstances, whether it is retirement, income for the family in the event of death or taking a sabbatical, will determine the amount of investments and the amount of insurance coverage. life you need.
It’s math time again…
The general rule of thumb is that for every R10,000 income you need per month, you need capital of around R3 million if we base the income at 4% per annum on capital/investments. Inflation is assumed to be 6% and the intention is that capital will be preserved for approximately 20 years. If any of the variables change, the amount of capital required will change. If the duration of the income is shorter or the preservation of capital is not important, the amount of capital required will decrease. The amount of capital required will of course also be affected by investment returns. The more cautiously you invest, the more capital you will need and vice versa.
In the event of death, the same formula as above can be used, but unpaid debts and death costs (executor’s fees and inheritance tax, etc.) must be taken into consideration and added to the capital amount required. If you have a solid investment base that will cover all of the above, you don’t need life insurance. On the other hand, if your investment base does not cover all of the potential expenses mentioned above in the event of death, then you know how much life cover should be retained or purchased.
Unfortunately, in most cases death is unpredictable and usually we just don’t know when we are going to die. If we did, planning would be much easier. In the planning world, we are still working on today’s assumption.
In other words, if you die today, how will your capital evolve?
I hope I have provided some guidance or assistance to help you decide whether or not to cancel your life insurance coverage. If you’re still in the dark, please send me a message and I’ll be happy to help you with some advice.
Live fully and keep investing.