Life insurance is an interesting topic.
It involves a ton of guess-work and assumptions about your career.
It taps in to our fears around losing a loved one.
It’s often misrepresented as to what it is supposed to do.
Some view it as a potential lottery ticket.
And there’s always the random occasional story about how some crazy poisoned their spouse or faked their death (shout out to Fletch) in order to cash out on their policy.
… who said personal finance is boring?
For most of us, the main question is “how much life insurance do you need?”.
What the Experts Say
I commonly hear finance gurus and professionals recommend some multiple of your salary.
Often times, it’s 10X – 12X. For example, financial guru Dave Ramsey says your life insurance policy should replace 10X your annual income.
While that equation is simple and easy to know what your income is – just pull out a calculator and hit the multiplication button – I think it over-simplifies things way too much. I’ll explain further in a bit.
Who Doesn’t Need Life Insurance?
First, let’s cross some of you off the list. There are those that do not need life insurance at all.
When I talk about who doesn’t need life insurance, I’m speaking of the insured being the person that were to die – vs. benefactors.
I don’t think the following folks need a life insurance policy:
- Anyone age 0 – 18: Nobody reliant on your income? No need for life insurance.
- Those with no present and future income: Generally, if you don’t have income, there is no income to replace in your absence (which is the whole point of life insurance).
- Those with zero dependents: If nobody is reliant on your income, you really don’t need life insurance.
- Those who are financially independent: If you are living solely off of investment income and no longer working, you have to assume that others will be able to live off of that same investment income. If they can’t? Their problem, not yours.
Who Does Need Life Insurance?
If anyone is dependent on your income to maintain their quality of life for the foreseeable future, you should have a life insurance policy.
A dependent could include a spouse, children, elderly parent, a relative with special needs, etc. It doesn’t really matter, as long as that person/people are dependent on your income and you want them to be a beneficiary.
Life Insurance and Debts
What about debts being passed on to others?
In general, when a person dies, their estate becomes responsible for any debts the person owed. The person’s executor or personal representative is responsible for paying those debts out of the property of the estate.
The executor is not liable for the debts, however, and does not have to pay them outside of the assets of the estate.
The exception would be if you had a co-signer on a loan or joint account holder. In that case, the burden would be shifted to the co-signer. If that person is not reliable on your income, this may be another example of when you would want a life insurance policy, so that person does not have to shoulder 100% of the burden of the debt. If the assets you co-own exceed the debt, it’s not an issue.
For all Others, how Much Life Insurance Should you Buy?
Over the years, I’ve come to a different conclusion from my original view on how much life insurance you need. Today, I believe that there is no one-size fits all formula. There are so many variables that should go in to life insurance calculations:
- savings level
- your age
- if you have a policy at your place of employment
- years of income lost
- expenses of dependents
- education of dependents
- income of dependents
- age of dependents
- asset level for you and your dependents
- debt levels for you and your dependents
Throwing out a random X times income variable is definitive and easy, but it doesn’t really do you any justice, and the end result is that you’re probably over-paying for your insurance policy.
However, I do have 10 rules to follow, and they should be a good guide for your own personal math:
- The true purpose of life insurance is to prevent financial hardship and a decline of quality of your dependent’s lives without your income. Nothing more. Nothing less.
- If you’re treating life insurance as a lottery ticket for others, the odds are not in your favor. Insurance companies have their math down to a profitable science, and those insured end up paying in more than they take out, on the whole.
- Expenses of your dependents in your absence are equally, if not more important, than your income. They should be factored in to any life insurance calculation. Nobody talks about this!
- Don’t forget health insurance costs! If a dependent relies on your health insurance, that is going to be a significant cost burden for them to pick up.
- If your dependents (namely, your significant other) have earning potential that meets their needs, you may not need life insurance at all. Their life will continue on, their income may increase, and they may even meet another whom they could team up with financially. For this reason, you probably need less life insurance than you think.
- Do not listen to the recommendations of anyone who actually sells the policies. They are going to suggest more life insurance than you actually need.
- If you have a hateful or borderline psychotic dependent, no life insurance policy is probably your best bet, until you can flee. I say that only somewhat jokingly.
- Price compare: just like with any insurance policy, rates and terms differ by company. Some require physical exams, others do not.
- Term life insurance is the best because it is the cheapest and easiest to understand. Other forms of life insurance carry larger commission from sales reps and are over-complicated. If you want your life insurance to become a retirement plan, there are better means to do so.
- Fear usually leads to you buying more life insurance than you need. Take that in to consideration when calculating your final #.
Life Insurance Discussion:
- How much, what term, and what cost is your life insurance policy?
- How did you come to that calculation?
- Have you decided to get rid of your life insurance policy or go without? Why?