Life Insurance: How Much and What Kind?

My dad loves to quote a life insurance salesman that once said to him “how do you know you don’t have a child?” As cringeworthy as the question is, it does address the purpose of insurance fairly well. Insuring against the unknown “what-ifs” that life holds.

Life insurance takes the place of your income in the event of untimely death. It is a source of reassurance that your loved ones will be well cared for after you are gone, which makes it one of the most important parts of your financial planning. So how do you know when you need life insurance? Ask yourself these questions:

Is anyone dependent on your income right now – spouse, significant other, child, medically dependent family member?

If the answer is yes, then you likely need life insurance.

How Much?

You can approach the question of “how much” in one of two ways. You can use the general rule of thumb by calculating 10x your annual income or take a more calculated approach based on the desired costs to be covered.

Example: You earn $80k per year. You would want to obtain a policy for $800k-$1M ($80k * 10).
What would you like to cover?

1. 5-10 years living expenses for you family ($60,000) or until your last child turns 18 (child is 1 year old)
2. Your home being paid off (outstanding mortgage $200k)
3. College cost covered for your child ($40k/yr * 4)

Example: Using the above amounts you would want to shop for a roughly 20-year term life insurance policy of $1-1.5M.

What type?

There are several kinds of life insurance, though a term policy is often more than sufficient to suit most goals and needs. The reason is twofold:

1. Those dependent on you will likely be self-dependent upon reaching age 18.
2. Your investment and retirement assets should reach a point where they would absorb the cost of care.

Whole Life insurance, unfortunately, is often over sold, though there can be a place for it in some estate and tax planning. The built-in expense and cash savings plan are two things you will want to be sure you fully understand if considering a whole life policy. The expenses are often high, and the returns rarely track the broader market returns.

So, what are the detailed differences between these two types of policies?

Term Life Insurance: covers the life of an individual for a specified period of time (usually 10, 15, 20 or 30 years). If the individual was to pass while still holding the policy in good terms, the designated beneficiaries of the individual would receive a predetermined payout of funds. The insurance is intended to provide adequate funds for the care of dependents upon the unexpected loss of the individual and their earned income. There is no other benefit other than the death benefit.

Whole Life Insurance: holds the same purpose of providing adequate funds for the care of dependents upon unexpected loss of the individual and their earned income, though without a “term” or end date to the policy. Due that they do not have an end date, Whole Life policies offer a savings and investment component where cash value accrues. The cash value investment can be accessed during the individual’s life and most often earns a fixed rate of interest. Due that there is no end date they are often used for the transfer of wealth upon death to beneficiaries.

The bottom line

Whenever insurance is available to cover a possible financial loss, we must address the fundamental risk management question of how much risk we can/should self-insure and how much we should shift to a third party through the purchase of an insurance policy. Always understand the purpose and understand the fees before you make your decision.

Good insurance providers should be able to help you reason through how much coverage you need and shop for quotes. For instance, Policygenius provides a calculator and representatives that will help guide your decision on how much coverage is right for your specific needs. Be sure to speak to an insurance professional to review your options in greater detail.

If you have questions about your broader financial plan and how to incorporate life insurance into it, contact Tull Financial Group today on 757.436.1122. We help our clients with a holistic approach to financial planning that takes into account income, investments, insurance and more.