As we continue on with In Case Shit Happens Week, we move from car insurance to life insurance. Financial planning is all about preparing for the future. Insurance isn’t a fun topic to discuss. Even for a future-minded person like myself. I’d much rather think about growing my income and my investment portfolio than thinking about what do we do when bad things happen. But, alas, it’s important to spend time thinking about the less sexy personal financial topics as well.
Insurance is the one financial product where we hope we never get our money’s worth. We pay premiums for coverage each year, and at the same time, hope we never have to use it. As Chris Rock said in his stand up, “I give a company some money in case shit happens. Now if shit don’t happen, shouldn’t I get my money back?” It’s a funny joke that obviously isn’t meant to be taken literally. We all know we’re paying for the peace of mind that in case shit happens, we’re covered.
With that said, one of the most important considerations when it comes to any type of insurance is making sure we get the right amount for us. Not for someone else whose situation is completely different. If we’re going to shell out money for something we hope to never use, then we don’t want to pay for more than we need.
Do You Even Need Life Insurance?
This is the first question to ask. Life insurance is very personal. There is no one size fits all. I find it amusing that people throughout the finance industry try to come up with a standard one size fits all number. For instance, many financial planners recommend obtaining life insurance that equals a set multiple of your salary, like 20x. That’s akin to saying everyone needs $1,000,000 to retire, without knowing each individual’s retirement expenses.
So how do you know if you even need life insurance? Here are some questions to consider when deciding what’s right for you.
- What are your current debt obligations? Consider purchasing enough life insurance to cover the outstanding balance on your mortgage and any other debt you have.
- Does one spouse not work? If this is the case, you’ll likely want life insurance to cover future expenses in case the primary breadwinner dies unexpectedly.
- How will you react emotionally if your significant other passes unexpectedly? Will you be too distraught to work? Or will you need work as a distraction to get you through the hard times?
- Do you have kids? How expensive are they? If they’re currently in private school, and/or you want to cover college tuition for them in the future, you’ll likely want a life insurance policy to cover these expenses.
As you can see, there are numerous different scenarios that impact whether or not you need life insurance. If you’re single with no debt and no kids, then life insurance won’t make much sense for you outside of a small policy to cover funeral expenses. However, if others depend on your income or you still have sizable debts, then you definitely want a policy to ensure the family is covered.
Types of Life Insurance
There are numerous types of life insurance policies. The two major types of life insurance are term and whole life or permanent insurance. Below is a brief summary of each. There are numerous subcategories of whole life insurance. For more information on the different types of insurance available, click here.
Term Life Insurance
A term policy is the simplest form of life insurance. Policies are typically purchased for a certain length of time, generally ranging up to 30 years. There are also one-year renewable term life insurance policies offered by many carriers. Premiums are paid for a death benefit only. If you die during the policy period, your beneficiary receives the death benefit. If you don’t die, then everyone is happy. The insurance company keeps your money and doesn’t have to pay out a death benefit. And you, well, get to keep on living of course!
Whole Life Insurance
Whole life insurance is sometimes referred to as permanent insurance. Why? Because such policies provide guaranteed insurance protection for the life of the insured. Whole life insurance policies are more expensive than term policies. This is because part of your premium is directed to the insurance portion of your policy (the death benefit), another portion goes towards administrative expenses, and the final portion goes towards the investment portion of your policy. The investment portion is referred to as the cash value portion of the policy. The cash value investment grows tax-deferred at a contractually guaranteed rate until the contract is surrendered (i.e. Stop paying premiums and withdraw the cash value, or the death benefit is paid out).
Which Type is Right for You?
Generally, whole life insurance policies are good for estate planning purposes. If you want to leave a large sum to your heirs, this may be a good option. Otherwise, I would stay away from whole life and go with a term policy. For many people, whole life policies provide more insurance than is needed. The investment portion of whole life is pushed frequently by financial advisors as a good safe investment (bear in mind that a whole life policy is one of the highest commission paying products that advisors offer). But after expenses, returns are typically very low. You’re better off paying the lower premiums on a term policy and investing the difference yourself.
How Much Life Insurance to Get
The biggest question most people face when deciding on life insurance is how much should you get? Again, it’s a very personal decision. Another question is, how long of a policy should you obtain? Here are some considerations when it comes to determining the right amount of life insurance for you.
- Consider getting enough coverage to cover your total debts.
- Match the term of your life insurance policy to the remaining term of your longest debt obligation.
- If one spouse doesn’t work or earns significantly less than the other, consider income lost if the primary breadwinner passes. Multiply this yearly income by the number of years left to retirement.
- Consider the life you and your family want to live if your spouse dies and vice versa
Let’s consider a few specific examples:
The Young Newlywed Homeowners
Jack and Diane both make $50,000 per year. They recently purchased a home with a 15-year mortgage of $200,000. Additionally, they have student loan debt totaling $50,000 with a ten-year repayment term. Jack and Diane should purchase a 15 year, $250,000 term life insurance policy. In the event that one of them dies before the loans are repaid, the other will be able to pay off all debt and maintain a similar lifestyle.
Mark and Jen, both 36 years old, are married with two kids. Jen left her job in marketing to be a stay at home mom eight years ago. Mark brings home a salary of $150,000 per year in his job as a software engineer. They have a $300,000 mortgage with 25 years remaining. The only other debt they have is a car loan with $15,000 left to pay over four years. As Jen has been out of the workforce for eight years, she will likely have difficulty landing a job. Any job she gets in marketing after an eight-year layoff will pay only a fraction of Mark’s current salary.
A conservative approach for Mark and Jen would be to buy enough life insurance to cover their debt, plus replace Mark’s income in the event he dies. At least until the kids are out of school. $315,000 in debt + $150,000 x 15 years = $2,500,000 policy
A less conservative approach would be to take out enough to service all debt, plus 4-5 years of Mark’s salary to allow Jen to get on her feet. $315,000 in debt + $150,000 x 5 years = $1,000,000 policy.
Where to Buy Life Insurance
If you’re a member of a professional organization, check to see if they offer life insurance policies. I’m a member of the AICPA and have a $300,000 policy that costs roughly $19 per month. Furthermore, the AICPA refunds premiums not used for claims and expenses back to the plan participants each year. Last year I paid total premiums of $230 and received a refund of $163. That ends up being $300,000 in life insurance for only $67 per year. It’s tempting to buy more, but at this point we don’t need it.
If you don’t have access to an organization that offers cheap policies like this, an easy way to get multiple quotes online is through PolicyGenius. I know many people who have used their services and have been very happy with the process and results. PolicyGenius is an independent site that is not affiliated with any insurers. All you need to do is answer some questions about yourself and you’ll receive a list of quotes from various insurance carriers in just a few minutes time. This cuts down on the amount of time you spend comparing options from different insurance companies. It’s never fun to think about what happens when a loved one dies. But it’s a necessary part of financial planning to ensure your family is taken care of in case of the unexpected.
Readers, how much life insurance do you have? What are your thoughts on the term vs. whole life debate? Have any of you used PolicyGenius? If so, please share your experience.