How Much Life Insurance is Needed?

 What would happen if you dies today?  Are you a father or mother of three small children who depend on your income for food, clothing or shelter?  Are you the primary caregiver for your children?  If you died, would your spouse need to put your kids in daycare and miss work if one of the kids were sick?  What if you and your spouse were killed together and one of your relatives or friends needed to raise your children?  Would they have the resources needed to give your children the things you wish for them to have?

Many people think this will never happen to them, or maybe just choose not to consider the possibilities, but the only thing worse than the tragedy of losing a spouse or parent is when that loss causes radical changes in the lives of those who are left behind.  If one does not have a significant amount of money and assets, the financial lives of your dependants may become very unpleasant.  Carrying adequate life insurance until it is no longer needed is a true way to show love to those who depend on you.

First of all, what kind of life insurance?  The answer is simple – level term insurance (probably 20 year – the time required to raise children and have them out on their own).  This type of insurance, when bought in ones early thirties, will typically cost less than $300-$600 per year).  There is no reason to buy whole life or the other bevy of products pitched.  These are nothing more than a lousy investment scheme paired with life insurance – one will do far better buying less expensive term insurance and then investing the rest without all of the fees and commissions tacked onto the whole life garbage.  If a salesman tells you different, ask what happens to your policy balance if you die.  The answer is that you balance – your savings – gets absorbed by the insurance company and you only get the face value of the policy.

How much is needed?  One can assume that one can withdraw about 10% per year from an equity investment account and have the money last for many years (one can withdraw about 8% per year essentially forever and never see the principle value decline).  This means that you need to have about 10 times your income available in a lump sum when you die to replace your income.  If you have no money in the bank, this means having life insurance totalling 10 times your annual income.  If you have substantial savings, this amount can be reduced since you are partially self-insured.  If you already have 10 times your annual income in liquid securities (stocks, bonds, cash, liquid real estate, etc….)  then you are fully self-insured and additional coverage is not needed (but it is so cheap, buying some would certainly not hurt).

What if you take care of the children and the house but don’t work?  Realize that if you were to pass your spouse would need to hire a nanny, maid, and perhaps other individuals to replace your contributions.  Just as with replacing income, figure out the cost of these services and buy enough insurance to amount to 10 times the annual cost.  Also don’t forget extra meals out and other expenses due to the hurried schedule of a single parent.

A final consideration is what would happen right after your death?  Would assets be locked up pending probate?  Would money for your funeral be needed and would family need to borrow money for these costs or put things on a credit card?  Be sure to consider these things and set up accounts/insurance policies and pre-pay for things as needed to ensure that your family will have adequate funds to pay for things while the dust settles.  Given that an estate can take a year or more to move through probate, be sure to designate beneficiaries as much as possible on all accounts since that money can often pass outside of probate.  A meeting with a good financial planner to discuss what would happen to your assets on death would be a good idea.

Finally, be sure to have a will and make sure people who ned the information will know where it is (or give them a copy).  Perhaps also keep everything someone resolving your estate would need in one drawer or file along with instructions.  Remember that organization is the difference between a smooth resolution of your affairs for those you love and a horrible nightmare that is not needed in a time of grief.

To ask a question, email or leave the question in a comment.

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Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

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