The Ultimate Emergency Fund

Building wealth begins with a strong foundation.  Today, you will learn the importance of having life insurance or as I like to call it the ultimate emergency fund.  Life insurance is the foundation of most people’s portfolio.  Interestingly enough, due to the over-representation of African-American insurance agents most of us know someone who sells life insurance.

Now, let me begin be saying that life insurance is not an investment, anyone that tells you otherwise is likely trying to sell you something that you don’t need.  Life insurance is protection.  It protects your family from financial hardship should you encounter an unexpected demise and can be used to provide a tax-free legacy to your heirs.

Some people do not need life insurance.  If you don’t have anyone that would be affected by your untimely demise then you are one of those people.  However, if you are like most of us, there is someone who would be truly affected.  Also ,if you have enough assets to cover all the expenses incurred upon your death i.e. you have $100,000 in assets then you don’t need a $100,000 life insurance policy, but  those assets will be subject to an “inheritance tax”. Significantly reducing the amount transferred to your heirs.

The two types of life insurance policies you will likely hear about term life and whole life”\.  Personally, I believe in the “Buy term, invest the rest” mantra.  The reason for that is because the premiums on a whole life policy are about 10x that of a term life policy, and by purchasing whole life you are giving the company your money to invest for you, while keeping a smaller slice of the pie.  Whole life policies usually give 4-5% non-guareented returns , where as the S & P 500 has returned an average of 7% since 1928.

The difference between whole life and term life is that whole life premiums are locked in for the length of your life.  . Whole life policies allow you to build “cash value” in the policy, but as I stated before I would rather make my own investments.  Also, if you are not going to die within the next twenty years, it is actually a poor “investment” as you may outlive its value.

Term life insures you for a period of 20-30 years.  It does not build “cash value”, however it provides you with a peace of mind.  Your loved ones will be financially taken care of with a tax free inheritance should you die. If you would like to know how much insurance you need simply multiply your current salary by the number of years until you reach retirement or the length of time until your child reaches adulthood

Ex.

40,000 per year x 30 years to retirement = 1,200,000

40,000 per year x 10 (years to age 21) = 400, 000

Nonetheless, you don’t really need that much insurance. My own personal policy is $100,000, but if I did have a child I would likely use the second formula.

li-life-insurance-needs

The chart above shows you the times when you will likely need term or whole life.  Notice how whole life is needed in the beginning of your life before college/work and about 10 years prior to retirement. This highlights another interesting use of life insurance.  Often, people get whole life policies on their children, its much cheaper, and allow the policies to build up cash value.  Once the child becomes of age the policy’s ownership can then be transferred to the child along with all the “cash value” tax-free.  It’s a pretty nice gift to a kid entering the next stage of life.

Life insurance has a place in most people’s portfolios. Before venturing further down this road to financial freedom and literacy, I suggest you speak with an insurance agent.  If you need a trustworthy one, I will be happy to suggest mine.

 

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