Insurance is an odd financial animal. It’s one of those few things that we pay for that we hope we never use. Life insurance certainly heads this list. We pray we never need to use our life insurance because if we do it means a loved one has passed away. But, we also know that death is a part of life and sometimes it comes much sooner than we would hope. Having sufficient life insurance can help make sure our families will be taken care of at least financially after we are gone. But, how do we know what kind of life insurance we need? How much is enough? Does my stay at home spouse need insurance too? What about my kids?
Why life insurance is important.
I listen to Dave Ramsey’s daily radio show each day. A couple of years ago I recall a program where he had two callers almost back to back that I will never forget. First a lady called in. Her husband had recently passed away unexpectedly. She had young children and large medical bills. Unfortunately, he did not have life insurance. She was in tears asking where she should even begin. It was a heart wrenching call. Amazingly, just a couple calls later another lady called in. Very similar situation Her husband had recently died of cancer. She also had young children. But he had several hundred thousand dollars of life insurance when he passed away. She was calling to see how he would advise her to invest that money so that she would have the income to support her and the children. Her heart was broken from her loss, but she knew she and her kids were going to be ok.
Two very similar situations with very different outcomes. Now I know that no amount of money could ever begin to ease the grief of losing a spouse. However, having insurance that will make sure financial worries are taken care of at least makes sure that there is one less worry for our surviving loved ones.
How much life insurance is enough?
If we remove the emotion of death and look at life insurance through the cold hard lens of finances, life insurance is basically there to replace us financially in the event that something should happen to us. You want to have enough insurance to make sure that if invested well your surviving loved ones could continue to live on the investments the same as if your salary was still coming in each month.
Dave Ramsey recommends that you have approximately 10 times your current income. So, if you make $50,000 per year you would need $500,000 in life insurance. The stock market historically has made just a little under 12%. If you figure on 10% then basically your life insurance proceeds could be invested by your surviving family and from a financial standpoint your income would be replaced.
Given the current volativity in the market I would recommend that if you can afford it, it would probably be wise to have even a little more than 10 times your income. You also might want to consider in addition to having 10 times your income, also having enough to pay off your existing mortgage on your house, and possibly enough to fund at least partially your children’s college.
Should you buy term or whole life?
On the surface this seems to be a no brainer for whole life. Term insurance exists for a period of time, often 20 years. At the end of 20 years it simply goes away. Whole life or universal coverage covers you for your entire lifetime plus it has a built-in savings program. So why would you ever buy term insurance?
The problem with whole life is it costs significantly more than term and usually provides less coverage, often by a factor of 10 or more. But I’m investing right? Yes, you are but the amount of return you get on that investment is generally very poor compared to if you had invested the same amount of money in the market. And here is the real kicker. If you die, your policy pays out the death benefit. But what about those savings that you had been accruing and paying extra for all those years? In most policies the insurance company keeps it. Not a good deal. The problem is, for these reasons, whole life is usually very profitable for the insurance companies and agents get very good commissions for selling them. Truth is though that whole life is rarely a good deal for the consumer.
Term life on the other hand has an expiration date or term. When the term, expires it goes away. There is no built-in savings program. It is simply insurance. However, you can usually get significantly more coverage for pennies on the dollar compared to whole life. What if you used all that extra money over the years of the policy to help pay off debt and your house and then to significantly add to your savings and investments? When the term expires you might have a paid for house with no debt and several hundred thousand dollars in savings. At that point you are essentially self-insured. You no longer need the insurance.
Beware these gotchas
- Term life is only better when you use that difference in what you are paying monthly for the policy to better your condition financially. If you fritter those savings away on pizza and entertainment, and the term expires finding you in debt with no savings and no insurance then you will not have gained anything by choosing the term insurance.
- If you currently have a whole life policy and want to change to a term policy, do not cash out the existing policy until you have the new policy in place. Last thing you’d want is to cash out your current policy and they get sick with something that would make you uninsurable before you got the new policy in place.
- Insurance rates are largely dependant on age and health. Think of it from the standpoint of the insurance company. A 70-year-old is more likely to pass away than a 20-year-old and therefore a greater risk. Someone who is a cancer survivor is more likely to have a relapse than someone in perfect health. Therefore the rates you qualify for will vary from person to person.
Who needs insurance?
- If you supply income that supports family members or other dependents, then you need life insurance that would replace that income if something happened to you.
- If you are a stay-at-home mom or dad, you still need some amount of insurance. You may not be “working” in the sense of bringing a salary into the house, but you are certainly providing value to the household. If something happened to you, your surviving spouse would probably have to hire someone to do some of the things you do.
- Do children need insurance? Generally no, unless it would be a very small policy to cover burial expenses. Certainly, it is hard to imagine anything more heart wrenching than the death of a child. But from a purely financial standpoint most children do not bring income into the household and therefore do not need insurance to cover them if the worst happened.
- How about if you are single and have no dependents? You really don’t need insurance as there is no one depending on you for your income if you were to die. From a purely moral standpoint if you have a lot of debt, you might consider a policy that would pay off your creditors if you passed away. Legally, this isn’t necessary as your debts would die with you, but morally you might consider it.
- Lastly, if you have no debt and significant savings, then you are at a stage of life where insurance is no longer needed. You are basically self-insured as your surviving loved ones would be ok financially if you were no longer here.
How can I get insurance?
There are many locations on the internet where you can get free quotes. One excellent site is Zander Insurance. Zander is an independent insurance agent and can thus get quotes from a variety of companies. What I like most about Zander is the quote process is completely anonymous, so you can enter your information in without fear of having a salesperson contact you unless you want them to. It’s a good place to get a rough idea of what rates might be for a person with your age and health. Best advice is to shop around and see what is available for you.
Money can never ease the grief your loved ones would feel if something happened to you. But knowing they are taken care of will give them peace in at least one area, during the most difficult of all times. It is one more way you can love your family well.