Saturday, September 15, 2007

Life Insurance: Do You Need It? What Kind? and How Much?

Life insurance is one of the more unpleasant things in life to think about. No one wants to imagine being hit by a bus. However, these risks are a reality and you should view life insurance as "income protection" insurance in the event of an untimely death.

When do I need it?
For most people the time to start thinking about life insurance should be about the same time they start thinking about having kids. After all, if you are single or newly married to a spouse with significant earnings potential of his or her own, no one is likely to miss your income too much if it suddenly goes away. However, when there are little mouths to feed, that's a different story. With lots of expenses including food, housing, healthcare, and education there are lots of things that little ones couldn't cover if you weren't around. The time to buy life insurance is when you are trying to concieve.

What kind?
Generally the only kind of life insurance that makes sense if you are trying to insure your income is term life. Term life provides a fixed payout in the event of your death for a fixed fee per month or year for a fixed period of time (i.e. 30 years). When the 30 years is up you have no insurance anymore. If you have been socking away money into your retirement account this should still leave you with a healthy nestegg if you have a problem after the term insurance expires or at least that is the goal. Most other kinds of life insurance (like whole, or return of premium term) are more akin to investment vehicles and while they may make sense for some people, they generally don't if you are young and just trying to protect your family. These other products can sometimes offer coverage until you die regardless of how long it takes.

How much?
I'm still trying to figure this one out. I have heard a general industry rule that says you should by 6-10x your annual income. The way I am thinking about it today is how much income does each person bring to the family today? Are we living comfortably off that income (or will we be when the munchkins arrive)? If so, then you should generally look to buy a policy that could provide that level of income from day one assuming conservative investment returns. So if you make $75k per year and you are getting a 30 year policy you want a policy that will assuming very conservative investment returns like 5% be able to produce $75k income per year (with some room for inflation at maybe 3%) for 30 years from investment gains and principal reduction. If you manage to live beyond day one of the policy that's a good thing and you will be more than covered, but if you don't at least your family will be taken care of. In the example above the amount required would be $1.65 mil in coverage, that's significantly more than the rule of thumb, but my assumptions are probably a bit hyper conservative. I have included the spreadsheets I used here in openoffice and excel formats. Just click on the format type to download. Once you know how much insurance you need, go get quotes on some policies at


Ron Phillips said...

Really appreciate the clarity of your piece on Life insurance. I wondered, though, why you just listed IntelliQuote as a source for buying Life Insurance?

I found agents have much more expertise. And they seem to have a good balance of excellent Insurance Companies that specialize in different health situations.

Armchair Fiduciary said...

Hi Ron. I liked intelliquote because I could get a quick quote right then and there without having to give much in the way of personal information. I agree that you might want to deal with a more experienced agent when it is time to purchase, but intelliquote can keep that person honest with minimal upfront hassle.

Term Life Insurance said...

Make sure to really shop around and compare quotes you get. The best deal is out there and you can find it.