Don’t get wiped out: Risk-Management for a Family of Five (feat. Emergency Funds, Disability Insurance, Health Insurance, Property & Casualty Insurance, and Life Insurance Planning)
April 9, 2021
By Matt Miner, MBA, CFP®
Today’s show takes the topic of Risk Management and puts it to work in a hypothetical case featuring imaginary clients Mike and Jennifer Murray.
Meet the Murrays
Mike is a consulting engagement manager with a big-four accounting firm earning $250,000 per year. His wife Jennifer homeschools their three children ages 10, 8, and 6. They own a $600,000 home in a leafy Atlanta suburb and we’re going to make sure they’ve taken the necessary steps to protect themselves in the event something terrible happens.
Risk Management Defined
Risk Management is not about insuring your iPhone or cordless drill. It’s about protecting what you can’t afford to lose: A lifetime of income, a big judgment entered against you in a liability matter, the replacement value of your home and personal property, and the massive contribution any spouse makes to the family’s financial life.
Key Take-Aways
Use the content of today’s show and the two that come before to create a risk-management assessment for your family.
Do you have an appropriate emergency fund?
Do you have all the right insurances in place?
Have you taken basic steps to be prepared for disasters that are likely in your context?
Have you made at least a basic estate plan?
It’s not enough to achieve big success on your money journey. It’s also mission-critical to avoid sustaining a loss from which you cannot reasonably recover. Addressing this risk starts with an emergency fund and well-designed insurance plan covering disability, health, property and casualty, and life insurance.
Download the Emergency Fund Whitepaper here.
Transcript
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[00:00:03] Matt Miner: The last two shows focused on a wide-ranging discussion of risk management topics with podcasting All Star Joshua Sheats. Today, we take those concepts and put them to work in a hypothetical case. Hey, and welcome to the Podcast. I'm so glad you're here. I'm Matt Miner, your money guide. Work Pants Finance is the show for MBAs, entrepreneurs, and other professionals who want their financial plan to work as hard as they do.
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Now, here's your Money Guide quick tip. Complete a risk management assessment for your family. How should you do that? Well, I'm glad you asked. First, do you have an appropriate emergency fund? Next, do you have all the right insurances in place? After that, you can answer the question, have you taken basic steps to be prepared for disasters that are likely in your area or context? Then finally, have you made at least a basic estate plan?
If you take today's content, you'll know just what to do to complete a risk management assessment for your family. If you want to talk more about your plan, you can get in touch with me at workpantsfinance.com/contact.
Today's show features imaginary clients, Mike and Jennifer Murray. Mike is a consulting engagement manager with a Big Four accounting firm, earning $250,000 per year. His wife homeschools their three children ages, 10, 8, and 6. They own a $600,000 home in a leafy Atlanta suburb. We're going to make sure that they've taken the necessary steps to protect themselves in the event something terrible happens.
Now, this episode is not about insuring your iPhone or cordless drill. It's about protecting what you can't afford to lose, a lifetime of income, having a big judgment entered against you in a liability matter, the replacement value of your home and all your personal property and the massive contribution any spouse makes to the family's financial life.
This show is called Don't Get Wiped Out, Risk-Management for a Family of Five. You can read more at workpantsfinance.com/16.
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We're here today to talk about the Murray family and their risk management needs. We're going to start with a review of their balance sheet. At the top of the balance sheet is their home. It's worth $600,000 and carries a mortgage of $400,000.
They've got a 2018 Honda Odyssey van worth about $19,000, a 2016 Chevy Silverado pickup truck worth about $30,000. $12,000 in their checking account, $15,000 in their savings account, combined IRAs worth $200,000, a 401(k) worth $400,000, and a health savings account worth $35,000.
They've also got remaining student loans from Business School of $80,000. That makes their total assets just over 1.3 million, their debt $480,000, and gives their family a net worth of $831,000. Which is pretty impressive since Mike and his wife, Jennifer are just shy of 40 years old. Now, I mentioned in the intro that they live in Atlanta, I've used an approximation of Georgia income tax rates in this analysis. This is a single earner family that itemizes their taxes.
All right. In the current year, these guys earned $250,000 on which they will pay the maximum Social Security tax of $8,537, and a Medicare tax of $3,625, federal income tax after deductions of just over $24,000 in Georgia State Income Tax just under $10,000, for the year 2020 for total taxes of just less than $46,000. That leaves them $204,000 unchanged to do something with.
Now, they choose to give $25,000 away each year. After their charitable giving, they have $179,000 left. We're going to start their investing with $26,600 going into the 401(k) and health savings account. We're going to include some minimum student loan payments of $10,000, leaving them $142,000 to spend during the year.
Now, that is their spending budget and that's going to be the number that will play into the emergency fund that we calculate for these guys. They've got mortgage principal and interest $21,750, property taxes and homeowners insurance $6,000, housing, maintenance and repairs $10,000, utilities $4,500, meals at home $14,400. That reflects the increased price of groceries in 2020.
Meals out $3,600. They can't go out quite as often as they used to in 2020 either. They've got no car debt, they have total annual expenses for their cars of $6,000. Entertainment and vacations, $10,000, personal spending, like clothing, hobbies, other things like that, $20,000, miscellaneous $20,000. Then we've got in here, a disability insurance budget of $3,500, a health insurance budget of $12,673.
We got auto insurance and personal liability policy of about $3,000. Then we've got life insurance for both of them at $5,000. Finally, their homeschooling supplies at $2,000 per year. Their budget then, to derive an appropriate emergency fund is going to be about $142,000 per year, which comes out monthly to $11,291 in spending that they need to support in the event of some kind of an emergency.
Now, since this is a single earner family, we're going to start at the far end of the normal emergency fund recommendation, six months of expenses. That would say that they should have an emergency fund of almost $68,000 socked away. On top of that, Mike earns a pretty good amount of money. In general, the more you earn each year, the longer it can take to find another comparable job.
If these guys were my clients, I would probably recommend that they beef up their emergency fund to some number greater than six months. 12 months will be 135,000 plus, $100,000 in cash might be a nice round number for these guys primarily aimed at covering any interruption in the family's employment.
Now, from there, I want to talk about their disability insurance needs. Even though it would be terrible if Jennifer became disabled, because she does not have her own income, she is not going to be able to get any disability income insurance. On the other hand, Mike with his $250,000 gross income would ideally look for a policy that replaces the highest percentage of that, that he can qualify for. Anything from $11,000 per month to $15,000 per month, would be appropriate in a private disability policy. Or he needs to understand that the policy that his employer provides is at least as good.
One thing you have to remember about disability income insurance is in addition to covering your family's ongoing monthly expenses, you also need to be able to save for retirement out of this income because you no longer have your employer-provided retirement plan where you can save money and get an employer match perhaps and things like that.
You really need your disability income amount to be above your lifestyle expenses. And/or in the terrible event that you actually become disabled, you'll need to lower your lifestyle expenses such that your disability income provides enough room above your lifestyle expenses to do some investing as well.
Now, if these guys are pretty healthy, I'm going to recommend that they do the qualified High Deductible Health Plan offered through their employer and max out their health savings account. Then they also pay out of pocket for minor medical expenses, which for a family like this, again, if they're healthy is going to be around somewhere between $1,000 and $4,000 per year, it's nothing that they can't handle in their ongoing budget.
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If you'd like to learn more about risk management, go to workpantsfinance.com/resources and download the Emergency Fund White Paper there.
When it comes to property and casualty insurance, the key for a family like this is high liability limits on both the auto and the home. The deal here is that they are on the hook not only for their current wealth of $831,000, but also for their future earnings. Any kind of reasonable capitalization of Mike's future earnings is somewhere between $5 and $8 million in value.
For something like this, people ask, "What's high enough?" They probably need the $250,000 per person liability coverage, $500,000 per occurrence, and $100,000 in property damage per occurrence.
Then to that, I would add a coverage that anyone with a good income or a good amount of wealth should have, which is a personal liability umbrella policy, sometimes just called an umbrella policy, sometimes you'll see it abbreviated as a PLUP. And for these guys, I'm going to recommend five to $7 million in PLUP coverage, an umbrella liability coverage for this family, because that's going to cover their current wealth, as well as the value of the future income that could be garnished in a judgment if they were to lose some horrible liability case. The good thing about umbrella insurance is that it's generally quite inexpensive. In the neighborhood of 100 to no more than $200 per million per year.
For this five to $7 million that I'm recommending, I would expect a premium of between 500 and a $1,000 in addition to their homeowners insurance policy. One of the questions that I get asked a lot is about how much life insurance people need. When it comes to term life insurance, which is what I'm going to talk about today, which is really just money to replace the economic value of the person who has tragically died. The way that I like to think about this is how much money would it take to make either spouse financially independent in the event of the unfortunate demise of the other spouse, right?
If a spouse dies, this is going to be a horrific time in the family for everyone and the last thing that you want to be thinking about is money, especially when for a relatively low annual amount, you could have just taken the entire money concern off the table and been able to focus your energy and resources on dealing with all of the personal and emotional concerns that arise out of the unexpected death of a spouse.
How do you figure this out? A simple calculation that anyone can do is to take their current spending, the actual spending that they need-- and this is going to be that same spending figure that we used to analyze the emergency fund, $142,000 per year, and then multiply that times 25.
Well, where do we get 25? That refers back to the 4% safe withdrawal rate, you can criticize that rate, but it's an excellent rule of thumb and good enough for a life insurance analysis. If we take $142,000 per year and multiply it by 25 and then subtract their current net worth of $830,000 or so, we come up with a need for just over $2.7 million in term life insurance and I want to say that that same amount of term life insurance ideally, would be purchased for both spouses, because even though Jennifer doesn't work outside the home, the value that she brings to the family is truly massive and if Mike had to replace what she's doing, either by hiring someone to do it or coming up with some other plan, the ideal situation would be that if he chose in the event of the death of his wife, he could also stop working and be fully financially independent at his previous lifestyle, to be at home and focused on his family through such a terrible time.
We're going to take that $2.7 million. We're going to call that $3 million among friends, and if they can qualify for it, my recommendation to this family that can easily afford that level of life insurance would be to have $3 million in term life insurance on each spouse.
Now what about whole life insurance? I'm just going to go ahead and call whole life insurance a savings and investment product, not one that is aimed at pure protection from death, and we're going to leave it out of a risk management discussion. At some future time, I may cover whole life insurance in an investments and savings products discussion.
Last thing that I want to say about risk management in the context of this show is that estate planning is a whole other topic, and we're not going to get into it today but at minimum, some of these risks would be brought about by the death of Mike or Jennifer, and so they need to be sure that they have a will or a revocable living trust in place, along with general powers of attorney, healthcare powers of attorney, advanced medical directives-- and this part is really important, careful instructions for proposed guardians and trustees for their children, given that they have quite young children and that really what they're planning for in the event something happens to one or both of them is the care of these children.
For these guys, Mike and Jennifer Murray, and taking it in the order that we discussed, the first thing that I'm going to recommend they do is beef up their savings account from $15,000 to at least $67,000 and I'm probably going to say unless they don't like the way this would feel, that they just target a $100,000 in their emergency fund.
The next thing that I'm going to recommend is that when open enrollment comes around, they get signed up in their qualified high-deductible health plan, and that they immediately begin maximizing their health savings account and pay out of pocket for any minor medical expenses.
We're going to review the liability limits on both their home and auto policies and make sure that they have maximum liability limits. Typically, that is 250, 500, 100,000 and then we're going to add to that a meaningful amount of umbrella liability coverage. We're going to recommend that they obtain between two and a half and $3 million in term life insurance for each spouse, if they're able to qualify for that and then last, but by no means least that they look for a disability policy that pays somewhere upward of $12,000 per month.
If they can get all those things in place, they really will have covered the risks that a family like theirs, if not likely to experience at least that could be an absolute disaster for their financial plan. Then finally going to anticipate things, not going the way that we want and have some robust estate planning in place behind this risk management plan.
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Today's show highlights that it's not enough to achieve big success on your money journey. It's also super important to avoid taking a loss you cannot reasonably recover from. Addressing that risk starts with an emergency fund and well-designed insurance plan covering disability, heath, property and casualty and life insurance.
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Thanks for sticking around to the end. I'll be right back here next week. Until then this is Matt Miner encouraging you to make a financial plan that works as hard as you do.
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Matt Miner is a fee-only, fiduciary financial advisor and Founder & CEO of Miner Wealth Management, a North Carolina Registered Investment Advisor where Matt provides personalized, unconflicted, advice to clients for a fee. He’s also my dad, so please be nice when you talk to him! Matt is a Certified Financial Planner Professional and holds a Series 65 securities license. He earned his bachelor’s degree in Finance from Arizona State University, and his MBA from Duke University’s Fuqua School of Business.
Work Pants Finance is Matt's financial media business where he talks about work, entrepreneurship, kids and money, taxes, investing, and other personal finance topics. WorkPantsFinance.com exists to share wisdom and provide general financial information. It is not financial, tax, or legal advice. You are an individual and probably need personal advice for your specific situation. You should consider building relationships with helpful, caring, and competent professionals who understand your unique context and can provide advice that is tailored to your needs.