How to Help Retirees Pick the Right Life Insurance: Hidden Value

Welcome to Hidden Value, the column where Joe Elsasser, CFP, answers common questions with insights advisors and their clients may not have considered.

QUESTION: My client has multiple life insurance policies. How do I determine what he really needs?

JOE ELSASSER: If life insurance has not been a part of your practice or you've been disappointed by the performance of life insurance strategies you've seen implemented in the past, consider the possibility that the policy itself wasn't the perfect fit for the job.

Working with retirees to get their finances in order, it's fairly common to come across clients who have accumulated multiple life insurance policies throughout the course of their careers. Many of these clients bought their first life insurance plan when their first child was born and bought a couple more as their personal economic circumstances changed. Life insurance, like any other insurance, is neither bad nor good. It exists to protect people from a certain risk or to deliver a specific economic advantage. How do you determine which policies to keep, add, sell or lapse? Advising which type of policy and what amounts are appropriate should be based on the ability to meet the client's needs.

There are two basic rules to life insurance:

Don't risk what you can't afford to lose
Don't buy more than you need

The key is identifying the client's precise risk mitigation need or desired economic advantage, and then determining whether the existing policy or policies meet that need. Life insurance products can effectively address several issues, including income replacement, liquidity at death, increased certainty of inheritance, and supplemental retirement income.

Income replacement Here's an example of how life insurance can help a retiree who needs income replacement. Consider a client who has pensions from several past employers and elected the "single life" option on all of them, with the expectation that he would outlive his wife. Although their relative health and family history would suggest that's not a bad expectation, it's not certain. When shown what his wife's living standard would be in the event of his death, he quickly recognized that some element of protection made sense. Determining how much is simply a matter of projecting the shortfall she would face in the absence of his pensions, after accounting for the fact that the cost to run the household will be less with only one mouth to feed. Consider a minimum premium universal life policy with a no-lapse guarantee. That structure will keep the premium costs as low as possible while maintaining the ability to meet the need at death. Term riders can also be effective.

Avoiding liquidating assets at death Another client owns and operates a midsize soybean farm and has two adult children. One child wants to run the farm and the other wants no part of it. In the event the client dies, there's not enough cash in the business to buy out the disinterested child. Life insurance could provide liquidity at precisely the right time. This is one example, but there are many situations where liquidity at death is extremely important to allow estate equalization without liquidating assets. In this situation the need is specific at death, so carrying significant cash value through the life of the policy doesn't add value.

Increased certainty of an inheritance (for a well-funded, but conservative client) You may have a client who is generally conservative, whose portfolio might lean as far as 80% bonds, and who is highly motivated to leave money to her children. She may be well-suited to use life insurance to provide at least part of the inheritance. Long-term care riders in these situations can be highly valuable because the leverage (risk-pooling) aspects of long-term care riders would protect a far greater portion of the estate than the conservative portfolio alone. Don't ignore partnership-qualified traditional long-term care policies for clients with lower account balances; that is often the better choice. Depending on how well-funded the client is, over-funding life insurance and carrying a significant cash value as a complimentary asset class with potential tax advantage can also be highly valuable.

Supplemental retirement income This has historically been one of the most commonly suggested reasons to purchase permanent life insurance. First, it's important to determine whether there is an at-death need. If there is, consider life insurance. If there is not, then there is a high likelihood this need can be met in a variety of other ways, such as a Roth IRA (subject to income limitations) or Roth conversions (not subject to income limitations). In some circumstances, there is no better way to meet the need than life insurance. Advisors should use the right tool for the job.

There are also a variety of business uses for life insurance, particularly surrounding key people, deferred compensation plans and other executive benefits.

So, what's the best way to add value here? As advisors, sometimes we're faced with no good choices — the wrong product was sold or bought and the penalties for exit are simply greater than the lack of advantage for staying. That's unfortunate, at best. My hope is that the industry will continue to evolve and becomes more focused on client needs and less focused on sales goals. In the meantime, here's three ways to find the hidden value for your clients:

Recognize when life insurance is the best choice to meet their retirement needs
Identify which type of insurance and product features are important to meeting the need with a high degree of certainty
Stay away from product features that sound great, but really are there to sell, not to serve

The most successful advisors build trust and lasting relationships by identifying the products that best meet an existing client need, rather than looking to create a need for the hot product of the decade.

— Check out How Do You Compare Two Financial Plans? — Hidden Value on ThinkAdvisor.