OK, we’re a month into the new year. How many of your resolutions are you keeping up with? In our last post, we talked about how this was going to be the year that you managed to get your financial house in order. After all, you (we) are not getting any younger.
In the first article in this series, we talked about spending and saving (It’s a New Year—Time to Get Your Financial House in Order). By understanding where you are spending your money and making sure that you are saving for emergencies and for the future, you will have a good foundation in place. The next step is to make sure that you have a good plan for protecting your assets. That will be the topic of this post.
Your plan for protection will depend on what stage of life you are in. A young professional will need a different protection plan than a retiree. That’s because the assets that they need to protect are different. The young professional’s biggest asset is her ability to earn an income. She has more human capital than financial capital. A retiree, on the other hand, has no human capital if he is not working any longer, so his biggest asset is a financial asset. That could be real estate, an investment or retirement account, or a business interest.
You can protect your assets from financial loss by transferring risk. You transfer risk by purchasing insurance. When you buy insurance, the insurance company assumes some of the risk. A good rule of thumb for all insurance decisions is to transfer the risk when the cost of a loss would be devastating. In other words, insure against the big loss. Let’s discuss some of the common risks you might face and how you might put a plan together that is appropriate for your situation.
Loss of Income
If you are in your working years, your biggest risk is likely to be the loss of income. That risk is compounded when you have others depending on you and your income. There are a few different ways you can lose your income. If you lost your job, your protection plan needs to include the emergency fund that I discussed in my last post. Having a few months of living expenses set aside makes a temporary job loss less of a problem.
What if you get sick or injured? Statistics show that you are much more likely to become disabled than die at certain ages. For example, for a 32-year-old, it is 6 1/2 more times likely you will suffer a disability than die. A long-term illness or injury can wreak havoc on a family’s finances. “Long term” can mean as little as three months.
The way to protect against this risk is to carry disability insurance. You can purchase short-term and long-term disability policies. Short-term disability insurance starts paying 60–70% of your income after being out of work for a few weeks and will generally pay those benefits for three to six months. Long-term disability policies pick up where the short-term policies leave off, usually starting to pay benefits after you’ve been out on disability for three to six months and paying for an extended term. Some policies will pay benefits until you reach age 65.
You can often get a group policy through your employer. You get the benefits of lower premiums through the group, but if/when you leave the employer, you can’t take the disability policy with you. Individual policies are sometimes a bit more expensive, but they are portable.
What about if you were to die? If you were to pass away, your personal need for income goes away. But if you have a family depending on you, the need to replace your income can go on for years. That’s when it gets more complicated. That’s why you should review your life insurance coverage.
Term life insurance can be a very inexpensive way to protect your family against the loss of your income. There are many different types of life insurance, but in most cases, a level premium term policy is the right choice. You can buy the amount of coverage you want, for the term you need, like 10, 20, or 30 years. Many people get their life insurance through their employer. It’s the same as with disability insurance—it might be less expensive because it’s a group plan, but it’s not portable if you were to change jobs.
So, if you are midcareer and have started a family, you’ll want to make sure that you have your emergency fund in place and that you have appropriate life and disability coverage. If you are a retiree, the emergency fund is important, but chances are you might not need life or disability insurance any longer.
In this post we looked at the different ways you could lose your income, and we discussed ways to protect against those risks. In upcoming posts, we’ll discuss some of the other financial risks that you may be facing. We’ll also discuss ways that you can mitigate those risks by putting a solid protection plan in place. We’re getting your financial house in order, step by step.