In part one of this series, I outlined the three basic layers of a sound financial plan – Protection, Accumulation, and Preservation/Distribution. In this article, I’ll discuss in more detail the elements of the Protection stage. There are five general areas that can require implementation of Protection strategies.
• Dealing With Unknown or Unexpected Shorter-Term Events. An important Protection strategy involves preparing financially for emergency situations, such as an unexpected job loss, an unforeseen large expense or the need for immediate income to cover expenses while waiting for proceeds from an insurance policy. A good rule of thumb for this strategy is that a household should have 3-6 months of expenses as a reserve for emergencies. If you live alone, are solely responsible for financially supporting your family, or have an inconsistent income or more tenuous job situation, however, it may be wise to have a reserve closer to six months’ worth of your expenses.
• Health-Related Expenses. These can come in the form of typical, run-of-the-mill medical expenses or costs incurred due to an extended illness or injury that not only requires medical assistance, but also impacts your ability to perform regular daily activities such as bathing or dressing. You can protect against the day-to-day medical costs with health insurance, which many individuals are able to obtain through their employment. Remember to be prepared to cover the out-of-pocket expenses. Long-term care insurance, on the other hand, can help protect against the latter type of expenses – those incurred when you need assistance with activities of daily living.
• Unexpected Death in the Family. What happens if your loved ones rely on your income to pay living expenses, save for retirement and/or pay off debt and you are not around to provide that income? Your family would likely have to dramatically adjust lifestyle and change long-term financial goals. Life insurance, however, can at least enable them to weather the financial storm brought on by your death. Life insurance is not a one-size fits all type of product. You need to consider your current assets, savings rate, income and income sources, expenses and family dynamics.
It also is important to have wills and accompanying legal documents in place. Consulting an estate planning attorney can be helpful here to help you set up or review your wills, advanced directives and medical and financial powers of attorney, amongst others. This is vitally important in the LGBT community where some of the legal protections afforded to married heterosexual couples do not exist.
• Disability or Extended Illness. A long-term disability or illness can be crippling financially. Indeed, losing your income in such a situation can force you to spend down any accumulated assets and possibly even incur additional debt merely so you can cover your expenses. Some employers provide disability insurance or the opportunity to purchase such insurance. When analyzing this coverage, you should consider how the insurance defines what is a covered “disability” as this can affect substantially how well-protected you are. Additionally, you need to consider the insurance’s elimination period (the amount of time after you are disabled before the insurance begins paying out), benefit period (the amount of time the insurance will continue to pay), the amount of coverage and whether the insurance provides inflation protection and/or the ability to increase your coverage as your income grows.
• Unexpected Property Losses and/or Liability Protection. Finally, to build a sound foundation to your financial plan, you also need to ensure you are adequately protected against substantial property losses and/or liability claims. To some extent, much of this protection is mandated by others. For example, if you own your home and have a mortgage, the bank likely requires you to maintain certain minimum levels of homeowner’s insurance.
Now that we’ve taken care of the Protection strategies, next time, I’ll jump into the fun stuff – how to work toward accumulating and building wealth.
(This material is for informational purposes only and is not intended to act as specific advice. Please talk to a financial professional prior to investing and a tax adviser for tax advice.)