Let’s Talk About Life Insurance
This isn’t an article about life insurance. I mean, of course, it is. But mostly this is an article about evaluating sources of risk in your financial wellbeing, and how addressing those risks can lead you to greater peace of mind.
Now let’s talk about life insurance.
For openers, do you need life insurance?
Not everyone does.
The way to answer that question is to start with the problem you’re trying to solve (risk), not the product (insurance). (Side note: This is a good framework to evaluate most financial choices: problem first, product second.)
Do You Need to Insure Against Risks?
A possible particular risk in your life is that someone is dependent on your current income and if you die, they’ll be left in a worse place economically.
The most common example would be if you are a wage earner and you have young children. That’s pretty obvious. But it may also be the case that the dependency arises from your unpaid labor as a caregiver.
It could also be that while you have no children or even a partner, someone else in your life is dependent on your income. Or it may be that a family member has co-signed a loan for you, and they would be stuck with that debt if you died.
But if none of the scenarios described above apply, it may very well be the case that you do not need life insurance.
There are many people who do not need to purchase life insurance because there is no risk. The loss of their income would not negatively impact anyone else.
This could describe a young adult, but as well it may be an older person who has no current income but ample savings to provide for family members.
Ah, but should I buy life insurance anyway?
Even if there’s no one who would be impacted financially by my demise?
Here’s a common argument:
“While I do not have anyone dependent on my income now, I may have children in the future. Wouldn’t it be cheaper to buy insurance now?”
If I had a crystal ball, I could definitely answer that question. But I don’t and neither do you.
The best we can do is consider the tradeoffs:
- If you buy a policy in your 20s (when you do not need it), your monthly premium will be lower than if you wait until, for example, your mid to late 30s.
- However, if you are in good health, the difference in the premium amount may not be that great. And of course, you will have paid premiums for an additional decade or so.
- Further, if you purchase a term life insurance policy in your 20s, you will almost certainly opt for a 30-year policy; as you are planning for a future family, you will not want the policy to run dry in your 40s.
- However, if you wait until you actually “need” the policy, you could potentially buy a cheaper 20 or 25-year policy – which may have a monthly premium that’s competitive with the 30-year policy you would have bought in your 20s.
There’s just no way to answer the question definitively.
A person who has significant health concerns will certainly have a completely different calculus of their risk i.e., the risk of higher future premiums.
However, there are online resources like this one that you can use to estimate your premiums under various scenarios, which may help you make the decision.
How much do I need?
If you do determine that you need life insurance, how much coverage should you buy?
There is a common rule of thumb that states the death benefit should be equal to at least 10x your annual gross income. And, absent any deeper analysis, that’s not at all a bad place to start.
Some people will look at that number and think it is quite high; yet, it may not be large enough.
What are all of the economic risks faced by your family if you die?
- Mortgage payment. Will your remaining partner want to stay in your same house? If so, their income may not be sufficient to maintain the home on their own. In that case, it would be ideal if there were enough insurance proceeds to pay off the mortgage.
- Other debts. Are there jointly held debts that would fall on the remaining partner, such as a car loan? Are there significant non-joint debts that would have to be settled from the proceeds of your estate? (By the way, federal student loan debts cease when the borrower dies.)
- Child Care Costs. If you’re partnered and have children, will the remaining partner need to engage childcare in your absence?
- College education. Absent your income, your remaining partner may not have the ability to fund your child’s future education needs. A policy covering the anticipated cost of college would be pretty useful.
- Retirement plans. If you’re partnered, it’s likely that your retirement savings projections were based on two people contributing to the kitty over the years. If one of those retirement contribution sources cease, will the remaining partner be able to make up the difference and have the same lifestyle as originally intended?
- Other savings. If your household has little cash savings, the death of one wage earner will not only affect future plans, it will inhibit the ability of the remaining partner to meet the urgent direct costs of your death (i.e., burial expenses) as well as other immediate but less direct costs, such as time away from work.
Read: Estate Planning for Millennials. [Yes, you need a plan.]
Bear all these factors in mind as you consider what may be your next question: “What about my workplace policy?”
Many employers offer a very low cost (or even free) life insurance plan with at least a small death benefit as part of your compensation plan. Probably everyone should take advantage of this, if for no other reason than to cover burial costs.
Still, considering all the economic risks listed above, is the workplace plan death benefit enough?
You also need to consider that when you leave your employer, the life insurance benefit ends; you may not want to be thrown into the life insurance open market at middle age.
Types of Life Insurance
I’ve deliberately talked about the problem – the economic risk of dying – and less so about features of the specific product, insurance. So, a quick nod to the eternal term versus permanent life insurance debate.
The basic facts are these:
- Term life insurance is straightforward. You pay a monthly premium for a set time period, as you choose, and if you die during that period of time, your beneficiary collects a benefit. It is the least expensive form of life insurance.
- Permanent life insurance is more expensive, generally much more so. It’s costlier for the obvious reason that, as the name implies, it is permanent. (Permanent life insurance is an umbrella category that includes “whole” and “universal” life insurance.)
- So long as you pay the premiums, the insurance is in force throughout your lifetime and through all of your future health concerns. The one thing the insurance company knows for sure is that they’ll have to pay the death benefit eventually, and so it’s priced accordingly.
Complexity — a lot of complexity — enters the picture as permanent life insurance policies include investment features; think of it as an “add on” that’s meant to take the sting out of paying many years of higher premiums.
When you purchase permanent life insurance, you’re buying both an insurance product and an investment product. You need to evaluate it as such and compare the decision to purchase a policy not just to other insurance products, but as well to other investment options available to you.
No plan for true financial wellbeing is complete without a consideration of the sources of risk in your life, and the deliberate actions to mitigate these risks.
For many, the necessary action includes purchasing life insurance.