Day 17: Evaluating Your Expenses in Life Insurance
Life insurance is a question that most of us simply avoid thinking about too much, especially when we’re young. However, if you have more than yourself as a dependent on your income tax forms, life insurance is something you need in order to ensure that if something happens to you those dependents don’t wind up in the street.
This is going to be the only expense evaluation where I might end up encouraging you to spend more money than you already are, but you will be able to sleep better at night knowing that those who depend on you are secure even in the event of something terrible happening to you.
First of all, your best option for life insurance is term insurance if you’re under fifty. Rather than regurgitating, this earlier post makes the case why term insurance is the best bet for younger people with their financial head on straight. An insurance salesman might try to coax you into whole life insurance or universal life insurance; don’t let them!
If you have one of the other types, you should strongly consider cashing it in and buying term insurance. Term insurance is substantially cheaper per month, enough so that it’s worth cashing in the other policy, removing the cash value, and instead start a term policy. You can take that cash value and use it to pay off debts; that’s more worthwhile to a healthy financial future for you and your family than universal or whole life insurance (note that I am not a professional financial adviser – I am not liable for any choices you make based on what you read here. Do your own research if you’re considering making a major choice that you might regret.).
Okay, so how much life insurance do I need? If you have no dependents besides yourself, you don’t need any at all. In fact, if you see little chance at having dependents in the future, just skip the rest of this entry because it really doesn’t apply to you.
I recommend getting insurance that will cover you until you’re 70 (or close to it), but if you’re very young, you may just want to get a 30 year term. Why? At that point, if you’re financially responsible, your estate should be in good enough shape that your life insurance isn’t necessary, and you can take that premium and do something else with it.
If you have only adult dependents, you should only need two or three years’ worth of salary in life insurance. If you’re under 35, a term policy for an amount equal to three years of your salary will be a trivial amount each month.
If you have child dependents, though, that’s when you really need good life insurance coverage. Take out a sheet of paper, find your last Social Security benefits statement, and do this calculation: calculate 90% of your salary, subtract your dependent Social Security benefit from that, then divide that amount by 0.08. That number is roughly what you should have in life insurance if you have any dependent children.
Here’s an example. Freddy has a wife, a child, and an $85,000 a year job. His Social Security statement reveals that his dependent benefit is about $11,000 a year. So Freddy calculates 90% of his salary ($76,500), subtracts his dependent’s benefits (leaving $65,500), and divides that amount by 0.08 to get $818,750 in term life insurance.
Why so much? You want any dependents to be able to invest that money and have the proceeds match your current salary with some breathing room. This calculation assumes a small 8% return on investment, which hopefully they can beat, but that’s not something you really want to bet on.
If you don’t have enough insurance, call your agent and discuss an increase in benefits. Most insurance companies will happily revise policies upwards for you because it means more money for them.
If you don’t have any insurance (and need some), start doing some research. Get some quotes on 30 year term policies and see which company has the best numbers. Then go ahead and make a purchase. This is something well worth fitting into your budget.
Tomorrow, we’ll go back to evaluating expenses with an eye towards cutting some money.