Walking through what happens if you or your spouse is not around is a mental exercise most people avoid. Unfortunately, that means when the day comes, we are not as prepared as we could be. Usually, this shows up when someone close to you has passed, especially if they have a young family. Money does not right all wrongs, but the difference between widows (or widowers) with life insurance and those without is telling. If you’ve seen this in life, and you know it’s time to get some for your family, here is how to figure it out.
Key Takeaways
- Life insurance is income replacement for those who bring in income for their family. It is especially critical for those in single-income families.
- For single-income families, life insurance for the stay-at-home spouse covers the expenses of their unpaid work, helping to ensure the professional spouse can continue to work.
- Conventional wisdom sets life insurance policies at 10 times your annual income; however, you should assess your full financial picture to determine the right amount for your family.
Step 1: Figure Out Who Needs Life Insurance
I spoke with a widow recently whose husband just passed away. One of the hardest parts of the conversation was when she said, “Now I have to go back to work for the first time in decades”. As a single-income family myself, my passing could put my wife in a similar position. It would be hard enough for my relatively young family to get through my passing. Making them go back to work feels like twisting the knife. It’s no wonder that the Bible talks so much about widows and orphans.
Here’s the takeaway: view life insurance as income replacement. Each family member who brings in income that the family lives off of should explore insurance. For those who are in single-income families, there is an extra sense of urgency for life insurance on the spouse who is working. When young kids are involved, this becomes even more critical.
There is an argument beyond income-replacement as well, call it expense-replacement. Especially for single-income families, it may be worth getting life insurance on the spouse. Would the working spouse still be able to provide for the family, work, manage the kids, and the house if the spouse were not there? Generally, if the desire is to roughly maintain the same lifestyle, there is a strong argument that life insurance on the non-working spouse could provide the resources needed for the working spouse to continue working.
As hard as it is, not thinking through this could be costly. Would your spouse have to go back to work? Would they have to sell the home? Move schools? Would your kids have to quit sports? Skip college? From a purely financial perspective, solving this problem is simply a numbers game. Buying enough life insurance to cover your current lifestyle can keep many of these negative outcomes away from your family.
Step 2: How Much Life Insurance Should You Get?
The industry had traditionally set the baseline somewhere around 10 times your annual income. If you make $100,000 per year, then around $1,000,000 would be your target. While I don’t disagree with this heuristic, applying it to your specific situation would make it better.
Start with all your debts. Would it be preferable to have them (i.e., the house) paid off if you were gone? Then, look at large living expenses, such as current schooling costs, health insurance, college savings, and others. Including lump sums for college or retirement, for example, can smooth the road post-mortem. Running the math on those expenses should give you relatively hard numbers to include in the life insurance policy.
Then, depending on your family, you may want to specify a number of years for which your insurance check would replace your paycheck. Would they need income for 5 years, 10 years, or permanently? The longer the replacement period, the higher the policy needed.
Once you add up the expenses and years of monthly checks, you should have a rough amount to target. Then it’s time to work in the other direction, specifically in terms of how many assets you already have.
For example, if you determine you need $1,500,000 in life insurance, and you have a $500,000 in a brokerage account, it could make sense to spend down that brokerage account “like it was insurance money”.
Remember, the rough goal is to keep the same lifestyle your family has now. If you have enough savings that cover everything above, then financially, there is little need for life insurance.
In total, calculate the amount of debt and expenses you want to pay off, add in several years’ worth of your income, and subtract out the amount of savings and other assets that you already have, and you are close to a useful insurance amount.
Step 3: Buying the Right Type of Life Insurance
For most people, buying term life insurance can be more than sufficient. Ignoring everything in the insurance world with all the different bells and whistles, the reason for life insurance is to solve the problems we discussed above. Term life insurance is the cheapest and cleanest way to solve that problem, in my opinion.
Generally, a 10, 20, or 30-year term life policy can be the sweet spot. Depending on your age and the family dynamics, that could skew up or down. But the ballpark answer is to cover the next couple of decades in case something happens.
Inevitably, though, you are going to run into other life insurance products, such as whole life insurance or universal life insurance. Both of these are referred to as permanent life insurance, meant to literally be held forever. They may be a good fit for some situations, but I would argue it is overkill for the majority of people. Insurance companies are incentivized to sell you permanent life insurance, especially if they can tie investments into it. Life Insurance is about protecting against the risks after your death, not solving all of your risks in life.
Hard But Good
Once all is done and your new life insurance policy is in effect, it may not provide much satisfaction. In the modern world, we willingly and purposely buy insurance in hopes that we are wasting money. I would prefer to live as opposed to my family receiving a life insurance check, obviously. However, taking the time to prepare your family in case the inevitable happens early is critical. Protecting your family when you are gone, in today’s world, also means giving them the means to operate financially. Take the time to figure out how much that is and make sure the policy you get does that job.
TC Falkner 