A conversation about legacy planning isn’t complete without a review of your insurance options.
Finance is all about the allocation of risk and the fair compensation for assuming that risk. This is the foundation upon which every investment portfolio is built, but it applies equally to other aspects of your finances, especially insurance. For folks with legacy goals, accumulating assets is often the financial priority most front of mind, and while that’s certainly part of the equation, without insurance, those assets may be at risk.
How Does Insurance Impact Your Financial Legacy?
Building a financial legacy, whether that legacy will support charitable causes, heirs, or a combination of both, requires accumulating assets, but it also includes protecting those assets from an unnecessary level of risk, which is where insurance comes in.
In the context of insurance products, you pay premiums to compensate the insurance company for assuming a risk that – were it born exclusively by you rather than distributed broadly among the insurance company’s many policyholders – could prove financially ruinous.
Of course, there’s no way to know whether one of these potentially financially ruinous situations may come to pass, but if it did, it could eat into some or even all of your accumulated assets. With fewer accumulated assets, would you still be able to meet your legacy goals? Depending on the situation, the answer might be no, which is why we can think of insurance as a way to safeguard your legacy.
There are myriad types of insurance, but for the sake of brevity, I will focus here only on those I have found, based on my experience doing insurance reviews with clients, to be the most overlooked or misunderstood types of insurance.
Among young people in what I refer to as the accumulation stage (the time between about 20 and 50 when your financial focus is on accumulating assets), disability insurance is one of the more overlooked types of insurance. Disability insurance replaces your income in the event of an accident or health crisis that leaves you unable to continue working in the same capacity and earning at the same level.
If you were to have a health crisis or accident that impacted your ability to continue working and you didn’t already have disability insurance, it’s likely that any legacy plans would go out the window as you switched into financial survival mode.
There are different types of disability insurance, and a good insurance broker can help you determine which one makes the most sense for you.
Life insurance is another type of insurance often taken for granted among those in the accumulation stage, but life insurance is at its most valuable and cost-effective in this stage of life.
In essence, life insurance protects your human capital, which is your future earnings potential. For most people early in their careers, human capital is their largest asset, because they haven’t had time to accumulate financial capital. If they happen to be married or have dependents that are counting on those future earnings, life insurance fills the void left by their untimely death. Even for folks without dependents but who have legacy goals, life insurance can help ensure the legacy that would have been achieved with those future earnings.
Life insurance typically adds less value as folks get closer to the end of their careers and their human capital diminishes, replaced by actual financial assets. However, there are still some situations where it can be effective, even in retirement.
For instance, if for whatever reason an older individual has not been able to accumulate much in the way of financial assets over their lifetime, but they still have strong legacy goals, upon their death, life insurance can step in for the inheritance or charitable giving they had in mind. Or, on the opposite end of the spectrum, if someone has accumulated significant assets over their lifetime, where they will be well into estate tax territory, they might take out a life insurance policy to cover the estate taxes, so their heirs are not stuck with the bill.
What is Umbrella Insurance?
Lastly, in my many years of working with clients, I have observed that probably the most overlooked type of insurance is umbrella insurance, which becomes increasingly important as your net worth grows.
Most people have auto and homeowner’s insurance, and they are probably familiar with the fact that these policies have some sort of liability coverage associated with them. For instance, if a guest gets injured on your property and decides to sue you, that liability protection kicks in and protects your assets, up to the liability coverage limit. The problem is most of the liability coverage built into homeowners or auto insurance typically tops out at around $500K.
So, what happens if, for instance, you are at fault in an auto accident with a high-income earner, such as a neurosurgeon or a professional athlete, and they sue you for loss of income and other damages because the accident made them unable to work? These are the nightmare scenarios that umbrella insurance covers, because without it, this situation could bankrupt you and put to rest any dreams you had of leaving a financial legacy.
Umbrella insurance raises the liability coverage limit across all of these other policies that have built-in liability protection, up to $1 million, $5 million, or more. Ideally, you want to raise the limits to keep up with the growth of the portion of your net worth that would be exposed to creditors in a lawsuit.
How Much Umbrella Insurance Do You Need?
Some assets, such as a certain portion of your qualified retirement accounts and part of the equity in your primary residence (depending on the homestead laws in your state), have built-in creditor protection. I won’t go into detail on these areas, but a qualified attorney familiar with the laws in your state can provide more definitive insight into your specific situation.
So, the amount of your net worth that is exposed to creditors will dictate the level of liability protection needed. As long as your liability protection is high enough to discourage a would-be plaintiff from going to trial and instead, accepting a settlement equal to or below your umbrella coverage limit, your umbrella insurance will cover your legal fees and the settlement amount. Again, consult a qualified attorney for more detail on this aspect of umbrella insurance.
All this to say, insurance has an important role to play in building a financial legacy, and many people take it for granted or neglect to think deeply enough about it. This is playing with fire, because life is full of risks that can threaten your financial dreams. But luckily, there are inexpensive insurance products out there that can help to hedge against these risks.
Part of good financial planning is doing a comprehensive insurance review to turn over rocks in your financial life and see if there are any gaps in coverage or exposure to risk you may not have considered. If you have legacy goals, I would strongly encourage you to embrace this process as a way to buttress your financial goals and protect your dreams.