Have you ever wondered if you need life insurance? And, if so, how much life insurance do you need? And how much does life insurance cost? And what’s with all the different kinds of life insurance?
Well, let’s break it down.
My philosophy of insurance as a whole
It is important to acknowledge that insurance companies make a profit on any class of insurance they sell. I don’t have a philosophical problem with that, but as a result, I will encourage you to only buy insurance that you need, in the amounts that you need.
Insurance’s job in your financial plan is to play defense. By that, I mean you should have insurance to protect your financial life from losses that you cannot (or do not want to) bear.
So, do you need life insurance?
Maybe. If you have someone who is dependent on your income to meet their daily needs, you need to ask yourself how they would survive, or even thrive, financially if you passed away. If you have built enough wealth, your family can use that wealth to thrive financially; if you do not have that kind of wealth, life insurance is a great way to provide your family with financial security when you are gone.
Some people believe that life insurance is a way to leave an inheritance. However, I don’t recommend that approach because life insurance is a very expensive way to leave a legacy. Remember, the insurance company makes a profit on every class of insurance, including life insurance. So, statistically speaking, you will pay more for life insurance than you will “make”. You would be better off financially if you purchase the “right” amount of insurance – and only of insurance that you actually need – and save the rest in a well-diversified investment. You will always own that investment but insurance goes away when you stop paying for it.
Budget booster: If you have life insurance and do not have someone financially relying on your income, you can cancel your life insurance and redirect that cash to another budget category!
If you’re worried about leaving your family responsible for paying for your funeral –check if you have life insurance at work. Many companies provide some life insurance –often up to $50,000 -to their employees as a no-cost benefit. If you don’t have “free” life insurance at work, do you have an emergency fund? The average cost of a funeral in the U.S. is around $10,000. Are you using life insurance because you are worried about paying off your debts if you die? Generally, if your debts are just YOUR debts, without any co-signors, then your debts die with you. An exception is when you have collateralized debt –like a car note with the car as collateral –in that case, the debt will die with you but the assets will be taken back as well.
So, if you do need life insurance, how much should you buy?
The answer to that question is in understanding the goal of life insurance. The best use of life insurance is to replace your income for people who are dependent on it for financial stability and to reach their financial goals. So, you want to purchase an amount of life insurance that, if invested appropriately, can generate an amount equal to your income in perpetuity. For that reason, I recommend life insurance in the amount of ten to twelve times your annual income. If your family received a lump sum equal to ten to twelve times your annual income and invested it in the market in a well-diversified portfolio earning a rate equal to the average return of the market over the past 50 years, they will have replaced your income for the long-term. (In general, there are no federal income taxes paid on life insurance proceeds.)
Stay-at-home moms and dads – I haven’t forgotten you! While your value is far beyond money, you need to estimate how much your family would pay in your hometown for the many tasks you perform every day: cleaning, childcare, chauffeuring, meal prep, etc. Then multiply that amount times ten or twelve, and your family should purchase that amount of life insurance for you.
So, how much does life insurance cost?
It depends on your age, gender, general health, and the amount and duration of the policy. In general, women live longer so their life insurance premiums are lower. Also, different types of policies offer different benefits and have different premiums. I recommend “term life” life insurance, which is the cheapest kind of life insurance. More on that in a minute.
According to Bankrate, the premium for a $250,000 term life insurance policy for a 25-year-old male and a 50-year-old man would be $22 and $81 per month, respectively. The same policy for a 25-year-old female and a 50-year-old female would be $19 and $61, respectively.
But don’t forget, if you don’t need life insurance, don’t buy it! Instead save the premiums and watch that money grow in your account instead of the insurance company’s account.
The easiest and most affordable way to price life insurance is likely through an independent insurance agency that can price your policy across many insurance companies; Zander Insurance company is one such agency.
So, what about all of the kinds of life insurance?
You have likely heard about many different kinds of life insurance: term life, universal life, variable universal life, and whole life are some of the most common. These different types of life insurance have different features but basically, they break down into two types: policies that are “just” life insurance policies and policies that have both life insurance and a savings component.
I recommend you purchase “plain-old” life insurance – term life – and keep your savings separate in a bank or investment account. Term life insurance is a commodity that you can price-compare among many insurance companies looking for the cheapest price. Once you put the cost of your term life insurance policy in your budget, your can use your budget to prioritize your other savings and spending goals.
If you pay more for the “savings” features in another type of life insurance, you are separating that amount of savings from the priority-setting objective of your budget. There are also fees for the savings features of life insurance that you need to consider when you look at projected returns on your savings. However, looking at life insurance like car insurance, you should choose term life insurance – just paying for the year’s cost of the insurance – and save separately from your insurance.
So, what about beneficiaries and wills?
One last thing, we can’t talk about life insurance without talking about beneficiaries –you need to update the beneficiary on your life insurance policy when your life changes. Nothing is sadder than when someone marries and starts a family but forgets to change their life insurance beneficiary from their parents–or worse an ex-! The life insurance company MUST pay the policy amount to the beneficiary, they have no choice –so update those beneficiaries!
And we can’t talk about beneficiaries without talking about wills. Let me be clear -everyone over 18 years old should have a will. It doesn’t have to be an expensive will; you can even use an online will if your financial life is not complicated –but you should have a will. If you die without one, the laws of the state that you live in will determine who gets what of your assets. If you want to decide, you have to make a will. Do you have enough life insurance? Do you know who the beneficiary on your policy is? Do you have a will?