Risk management is planning for the “what if” scenarios that no one wants to occur. What if I become disabled? What if I am subject to a lawsuit? What if I pass away prematurely? These unfortunate scenarios could have a significant negative impact on your family’s financial security.
The hope is that these scenarios never occur, but there are no guarantees they won’t — so planning should be done to protect your financial security if they do. The type and extent of risk management planning, like other areas of wealth planning, depends on your current situation.
Take Care of Your Family by Planning for Income Replacement
What happens if the wage earner in the family passes away prematurely and there are not enough savings to support the family for an extended period of time? Given the current cost of living, many families need two incomes, and the loss of one of those incomes could result in serious financial difficulties.
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Risk management planning in this situation is to develop a plan so that there are enough resources to insure your family’s financial security. This starts with building an emergency fund, which provides the temporary funding to support the family. Normally it is a good idea to have enough to cover close to six months of expenses. These funds should be liquid (easily converted to cash) and therefore immediately available.
The emergency fund is only meant to be a temporary source of funds, not long-term financial security. Additional planning will need to be done with the goal of generating enough funds to replace the income of the deceased spouse. Generally, the most cost-efficient way of doing this is by purchasing term life insurance with a large enough death benefit, or disability insurance to provide the income replacement protection needed. A wealth plan can help determine the amount of insurance needed to meet the desired financial goals.
Don’t Leave Yourself, or Your Family, In a Cash Bind
In certain situations, planning will need to be done to generate the liquidity needed to achieve certain goals. For example, say there are two people who are equal owners of a successful business. If something were to happen to either one of them — such as a premature death — neither partner may want to run the business with the deceased partner’s family. One way to avoid this is to enter into a buy-sell agreement funded with life and disability insurance. The buy-sell agreement would likely be drafted to give each partner the right to purchase the deceased partner’s share at a specified price, with the insurance providing the liquidity to execute this option.
And for those with large enough estates that would make them subject to estate taxes, liquidity planning is important to ensure there are funds available to pay the estate taxes. This is especially true for those whose assets are mostly illiquid (e.g., real estate or ownership of a closely held business). By having a plan to provide liquidity (such as purchasing an insurance policy), your family could avoid having to sell assets to pay estate taxes at your death.
Limit Your Legal Liabilities
An important part of risk management planning is not only planning to provide financial security for your family in the event of your passing or disability, but also protecting your assets from other possible risks while you are alive. If you are in a profession that could make you subject to personal liability and lawsuits (e.g., doctors and attorneys), it is important to protect yourself from these litigation risks.
Through the planning process, we can explore the different actions that can be taken to insure the financial well-being for you and your family. Actions such as the creation of qualified retirement plans or certain trusts that can offer a level of creditor protection.
For Peace of Mind, Just Do It
The discussions regarding risk management planning are not pleasant. They are the scenarios we hope never happen. A lack of a wealth plan could have disastrous consequences to your family and could jeopardize their financial well-being. By undergoing the planning process now, you can have the peace of mind that your family will have financial security even if these worst-case scenarios were to occur.
This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.
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