A little about Term life insurance policies. (free download at end of article!)
”Insurance is like a parachute. You have to have it before you need it.” -Unknown
Is there anybody who depends on your income besides yourself, such as a spouse, children, or parents? If so, you have a need for life insurance. For most, a simple term life insurance policy will be a good choice.
Life insurance isn’t a cure to revive you from the dead; rather its purpose is to eliminate the financial consequences of your death.
In order to figure out how much life insurance you should buy, you will need to first determine what your financial plan would be if you died tomorrow. Then you should buy enough insurance so that you continue to financially provide for your dependents as if you were still alive. Honoring the most precious promises you make to your loved ones.
Figuring out the appropriate amount of insurance can seem challenging. It involves some data gathering, making some assumptions, and some number crunching. Fortunately, when we prepare financial plans, all that information is readily available. We can give you sound recommendations based on your individual situation.
To avoid getting into the weeds of our process, lets look at a back of the napkin approach to give you an idea of how much to purchase.
The goal is to provide a nest egg that your dependents can draw from to maintain (at a minimum) their current lifestyle. For this quick calculation we’ll use the well popularized 4% rule of thumb for a safe withdrawal rate. Begin by taking your monthly after tax expenses and multiply them by 12 to get your annual spending. Now multiply that amount by 25 to get a base amount of investable assets to apply the 4% rule to (4% = 1/25). Add other items that would need to be paid for like a mortgage, children’s education, and large ticket items like a vacation home or student debt. This should give you the amount you need to cover. Subtract what you currently have in savings and round up to the nearest $100k. With the above steps you should have a good idea of the amount of coverage you need.
How Long of a Term?
Insurance is there to protect you from a catastrophic event that you cannot absorb alone. You enlist the help of an insurance company to share all or a portion of that responsibility to them. For life insurance, the term of coverage will hinge on when you arrive at financial independence. At that point your nest egg should be large enough to provide for your spouse or other loved ones that financially depend on you, for the rest of their lives with or without you. As you get closer to retirement, your life insurance needs generally decrease. At that point your children are hopefully independent and your retirement savings (with the proper planning), will meet your spouse's living needs.
Once you figure out the time line for your financial independence you have a few choices of term policies to consider. The simplest and most popular is called level term. A level term policy insures you are covered for a fixed period at a fixed cost. For instance, if you purchase a 20 year level term policy for $1 million dollars of coverage at $XX cost, you can maintain that coverage at the same cost for all 20 years. At year 21, if you choose to renew your policy it will cost significantly more as your age puts you at greater risk.
Level term is predictable and is often the best choice. However, other options are available. For instance, if you are a high earner and expect to become financially independent early in life, an annually renewable policy will be something to consider. It will be less expensive than a level term policy in the beginning but as your age increases so will the cost. Another option is to combine (ladder) multiple level term policies together to meet your needs. For instance, if you have a 30 year time horizon, you could purchase a 20 year level term and then tack on a 30 year level term for half the coverage. By laddering you can better match the insurance needs with your stage of financial stability.
Insurers have a rating system for your health risks. The lower your health ratings, the higher your premium costs. In certain conditions you can be denied entirely. So get in shape, feel good and save money.
Review these every few years or any time there is a life changing event.
Group policies provided by your employer are often the cheapest plans you’ll find and sometime entirely free. Find out what benefits your employer offers. The amount of coverage is usually tied to your annual salary. It could be one or two times your base salary. Though this is a great benefit it isn’t portable if you leave your job. Do not rely on this for the insurance your family depends on.
If you have financial dependents, life insurance should be your #1 priority. Nobody wants their family to create a gofundme page.