Most people know they need life insurance, but don’t know how much. If you have loved ones you want to protect in the event of your untimely death, don’t you think it’s important to know exactly how much life insurance you need? With just a little effort you can analyze your family needs to make sure you have the proper amount of life insurance.
Insurance transfers the risk to someone else
You have insurance for your home and car, right? You’ve also probably purchased insurance or warranties on phones, televisions, lawn equipment, even vacations. That’s because if a lightning strike ruins your TV, router, printer, and DVD player (happened to us), or your toddler throws your phone into the tub (happened to us), or a hurricane interrupts your vacation (you guessed it, happened to us), you don’t want to have to pay the full cost of replacement. You’re now also probably nervous about coming to our home or going on vacation with us!
Warranty on your life
When it comes to purchasing a warranty on our future income and savings with life insurance, very often we resort to the amount we think is good enough – a decision with little thought and almost no analysis.
Life insurance is not something you want to guess. What number looks good to you, 2x, 3x, 10x your income? You’ll end up either under insured or over insured. Yes, it is possible to be over insured. It’s not as common of course, but it does happen. Do you want to pay for something you don’t need, or worse yet, believe you have enough life insurance only for your family to find out that you didn’t?
The family needs analysis
There are a number of ways to figure out your insurance needs. My go-to method is the family needs analysis. It determines the amount of life insurance it would take to ensure your family could meet its current and future financial requirements. The family needs analysis breaks your family’s financial needs into three categories, immediate needs, future needs, and existing resources.
The needs at death and shortly thereafter while your family adjusts and copes through a difficult time.
- Final Expenses: Burial, estate, estate tax, etc.
- Medical Bills
- Debt: Credit cards, personal loans, auto loans
- Mortgage: An amount that will pay off your mortgage. Some people prefer to not pay off the mortgage but instead build it into the future needs as an ongoing expense, but I recommend paying it off.
- Buy/Sell Agreement: If you are a business owner you should have insurance to cover the transition of your business. This should probably be a separate policy.
These are the expenses you want to eliminate during an already stressful time. By paying off all the debt, your family can begin the difficult transition without that hanging over their heads.
This is the meat and potatoes of your insurance analysis. The ongoing needs to meet the day-to-day financial obligations and living expenses of your family.
The first and most important question that must be answered is, how much of your current income will need to be replaced and for how many years? Hopefully, you have a budget in place to help you quickly determine how much of your income is necessary. You do have a budget, right?
There are two elements of projecting your life insurance needs that must not be forgotten. First, your income and cost of living are not static. You do get raises, and a dollar in the future will not go as far as it does today. Plan for that. Secondly, do not forget about the amount you save for retirement and the fact that if you keel over your spouse will get the higher of either your or their Social Security benefits, not both. Plan for your spouse’s retirement as well.
Other possible future expenses
- College funding
- Charitable bequests
- Emergency fund
Add up all of your savings, retirement accounts, non-retirement investments, any real estate that would be sold at death, existing life insurance, piggy bank, cash under the mattress, etc., and subtract that from your total insurance needs and there you have it, an accurate analysis of your insurance needs.
Get on the stick
You don’t have time to waste. Insurance covers the unexpected. We all hope that we live to a ripe old age, but you never know. So open up a new spreadsheet, get out the paper and pencil, or dust off the abacus. Actually, it’s not that difficult. There are plenty of calculators online that can give you an accurate assessment.
I recommend using three different calculators if you want to do it yourself. It could be those three or three others. Not every do-it-yourself calculator is perfect, so getting an average among a few can give you a more accurate analysis. The other option, of course, is to give your fee-only CERTIFIED FINANCIAL PLANNING™ professional a call to get an analysis done.
Does everyone need insurance?
No, everyone does not need insurance (that noise you hear are insurance agents gasping). There are those that can self-insure or are at a point in their lives when the debt is paid, the kids are on their own, and retirement is soon at hand. The need may not be there.
If you’re single, no kids, with no one who depends on you, then you probably don’t need life insurance either, or if you do, it would be a minimal amount.
Life insurance needs are not static
The amounts of life insurance you need at ages 25, 45, and 65 are going to be very different. As with every financial analysis, it’s not a one-and-done deal, but an ongoing process to be reviewed every few years. Put it on the calendar to review every 5 years, or when a life-changing event such as a marriage, or the birth of a child occurs, whichever comes first.
Which should you get? Term vs. Whole life.
A term life insurance policy has a set amount of coverage for a specific period of time, usually 10 – 30 years. If you die during that period your beneficiaries get the death benefit.
You can get the annual renewable term, which gives you one year of coverage at a time, that you renew annually, at ever increasing premiums. The other more common option is a level premium term. You buy the policy for a specific period of time and the premium is fixed for the length of the term.
Unlike term, whole life policies are designed for your whole life, hence the name. Since you’re going to die the insurance company knows it will have to pay out the death benefit as long as you keep paying those premiums. Therefore the premiums for a whole life policy are significantly higher than a term policy. There are also some tax benefits for the savings portion of a whole life policy that may be available for your use in the future. That benefit adds to the premium cost.
A whole life policy is a mix of insurance and investments and besides having significantly higher premiums it also has commissions, fees, and surrender charges that make them only appropriate for a specific group of people.
In my opinion, this is pretty straightforward. If you want to protect your family against a loss of your income, term insurance is the way to go. In fact, probably two or three different term policies for differing amounts and time periods would work best complemented by employer-provided insurance.
Who should think about a whole life policy? If you have more than $300,000 of annual income and greater than $2 million in assets then it’s time to think about a whole life policy. But listen, if you don’t fall into that category that doesn’t mean you should go out and cancel your whole life policy today. That opens up another can of worms. Talk to a fee-only professional before you do anything.
Need objective help in assessing your family insurance needs? Contact us here to schedule an appointment.