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This questions was answered by Jeff Rose, Certified Financial Planner in Illinois who authors the blog Good Financial Cents and is the co-founder of Alliance Investment Planning Group.
Life insurance questions
DFA reader Anthony asked:
Here is a quick time line of my past year or so:
- December 2008: My then-girlfriend, now-wife, and I purchased a house. The mortgage is $165,000.
- April 2009: I got married.
- December 2009: My first daughter was born.
So yes, my last year has been a very quick-pace and exciting one. But for the last couple of days, I have been thinking about my life… and life insurance. I know that I need life insurance, this is not a question of “whether or not.” The questions are: how much? what type (term vs. permanent)? should I get some through work or somewhere else? In my hunt for knowledge, I found a few things out. First, the “how much” ranges anywhere from -$200k (that’s a negative dollar value) to $1.3M. The top end ($1.3M) comes from a 20x salary rule of thumb. The -$200k comes from a fancy online life insurance calculator: It implies that my wife would be completely self-sufficient without me, and this is actually true. If I died today, she would have grief and pains and her lifestyle would change (of course!), but her income would pay all of the bills. That being the case, I have seen tons of PF bloggers talk about $1M+ policies. I definitely feel that this is overkill.
On the other hand, $50k is the minimum policy most (?) companies offer. I even walked through my numbers with a State Farm agent: According to that exercise, I would get $200k. Where do I fall in? What number should I go with? (I know that this is a personal, “comfort” level question, but I am curious about everyone else’s response.)
Second, term vs. permanent? The PF world feels that term is the way to go: You can invest the difference in premiums on your own and come out ahead. After some research, many people seem to like permanent. Then again, I could always take two policies out for one of each. What should I do?
Third, getting insurance through work or through other means? My job offers me a plan for $500k for about $11/month. That sounds great, but their insurance policy lapses when I am no longer with them, not when I die. So if I don’t die before I leave the company, it’s not worth it, despite it’s incredibly low rate. On the other hand, life insurance companies are more expensive for a smaller death benefit. However, I am covered, regardless of my job status. Also, I remain insurable if I hold any type of policy with a particular company. My thought is to max out my company’s plan, which would leave me over-insured, but it’s so darn cheap. But also, I want to start a policy elsewhere so that I can remain insurable. What do I do here? What are yours and the reader’s opinions on these questions?
How much life insurance should I purchase? 2. Should I get term or permanent insurance? Or a combination of both? 3. Should I max out my company’s plan? Should I go with a plan outside of work? Or should I do both? Thanks, Anthony.
Life insurance – What type and how much?
Anthony, deciding how much life insurance to buy can be a tough decision to make as proven through your own personal experience. There are many options and choosing the best life insurance for you and your family can be tough. First, let me say: there is no “right” answer. The many different options to weigh:term vs. permanent life insurance, 30 year vs. 20 year, third party vs. employer, are all a moot point. The fact of the matter is: get some sort of life insurance to make sure your family is taken care of.
I recommend term life insurance
Personally, I’m a HUGE fan and consider term life insurance the best choice for many situations. That’s the way I go and that’s the way I recommend to my clients. Whether you purchase $500,000 of term life or $1,000,000, what you pay per month/year on the premium is trivial compared to the benefit to your family in case of your unexpected passing. It’s just too simple of fact, term life insurance is cheap to buy.
As I read over your situation, I could relate as I went through the same process. When I first married, I bought a $250,000 30 term policy. After we had our 1st child (about 2 years later), I added an additional $500,000. Recently, we just built our first home, had had our second child and; with me just turning 32 (ouch,) I didn’t want to take the chance of having go through another life insurance medical exam and run the risk of being denied or have my premiums shoot weigh up. I opted to tack on another $1 million term policy.
Here are a few of the things I based my decision on:
You can take a look at a post I did, how much term life insurance do you need to buy, that uses the same rule of thumb that you found (20x your salary) or is based on a needs analysis. The needs analysis main focus is to provide an income replacement for your spouse while you’re gone, not just to pay off any current debt or funeral expenses.
The logic I used in my amount was that I wanted my wife to have at least an $80,000 per year income if something happened to me. Based on a conservative number of earning say 5% on the money and if invested, that should do just that. Is $80,000 a year excessive? A single mom raising two kids that needs to last her the rest of her lifetime- I would say not. Plus, the premiums are extremely affordable.
If you want to take out some permanent life insurance to give you some peace of mind, then go for it. At your age, I wouldn’t necessarily advise it. Here’s a look another look at what is better, permanent vs. term life insurance.
Company insurance plan – Should you max it out?
Your company’s plan is an option, but I wouldn’t have it be your main focus. What if you lose your job? What if your company goes belly up? What happens if this happens when your 45 and forced to get life insurance when you’re older. By going through an outside carrier, you’ll never have to worry about it.
To play devil’s advocate to myself, $11/mo for $500,000 is cheap. I’m pretty confident though you could find an outside carrier that would offer something equivalent.
Remember: Be sure to shop around! You would be amazed at the difference that one insurance company will charge over another.
As usual, be sure to review your insurance needs on a periodic basis. $1.3m might seem like a lot of life insurance today, but five years for now it might not be enough. That’s exactly what I thought when I had $750,000.
Matt’s note: Anthony, I agree with Jeff. For our family we also carry term life and believe it to be the best option by far. I carry more insurance on my wife than on myself and make sure her coverage is commensurate with how well I want her to be taken care of in the event of my death.
*Investors should carefully consider the charges and fees associated with a new insurance policy as well as any costs associated with surrendering the current policy.
*Jeff Rose is a registered with and Securities offered through LPL Financial, Member FINRA/SIPC.
*The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine what may be appropriate for you, please consult your financial advisor or local insurance agent.
Debt Free Dude says
Term life insurance is currently priced very cheap, so it is a good time to get it. Plus it is always cheaper to get the insurance today than it is tomorrow when you are older (and more likely to kick the bucket). There are online brokers that will submit your request out to bid with a bunch of different companies. This can be a good way to make sure you are getting good pricing. (I’ve used eInsurance.com and been happy with them.)
Also your home insurance company, retirement company, and bank may all offer life insurance if you want to stick with someone you know.
Bible Money Matters says
I’m buying my term life insurance policy this week, just waiting on my medical exam on Wednesday, sending in the paperwork, and I should then have a policy worth 10 times my annual income – for a minimal monthly payment. Term life all the way!
Budgeting in the Fun Stuff says
We are in a similar situation but went the other way.
My husband and I are in our mid-late 20s, have no kids, can live off of one salary if necessary, have stable jobs, have a $11,000 car note, and we have a $73,000 mortgage.
I get my short-term disability, long-term disability, and life insurance ($100,000) through my job for less than $14 a biweekly paycheck. My husband gets his life insurance through his job and is adding both disabilities during his next open enrollment period.
This makes since to me since our jobs are stable, we have no kids, and we are building enough cash reserves that we won’t need insurance at all in 15 years or less. We are only insured for $100,000 since that will cover the mortgage and car…we’re ok with providing for ourselves if the need arises.
In short, we see insurance as backup and aren’t worrying about it too much. It would be the end of my emotional world if my husband dies, but I’d be fine financially…all we use insurance for is to get rid of the debt burden so the survivor can take extra time off if needed.
Obviously, we’d need more if we had kids or a giant mortgage or something, but I’m taking advantage of our specific situation.
Matt and Jeff,
I appreciate the response!
Since I submitted the article, I went ahead and maxed out my company’s insurance policy. As mentioned in the article, I’m covered for $500k for $11/month. I have not yet seen anything this cheap with an outside carrier.
Also, I am in the middle of purchasing a $100k 30-year term policy for $22/month through State Farm. My auto and home insurance are there as well, so I’m getting a *small* discount on my auto and home policies.
All in all, I agree with the comments in the article. I finally decided to just stick with a term policy. If I need to, I can “stagger” more policies later on in life.
My two cents here…I’d take (but ignore) the company plan. It’s inexpensive, but jobs have a way of disappearing, and when it does your insurance will be gone as well. Right now you have youth and health, and that may not be the case in 5 or 10 years if your job is gone.
Even though your wife is currently self-sufficient as far as income, you probably should ignore that when buying insurance. Assume instead, that your family will be fully dependent on your income at the time of your death.
Insurance is a bet on the “what if” question/scenario, so you should plan for the worst case scenario. Since your child was just born, you have to consider that all kinds of scenarios are possible, and you need to consider the next 20-25 years in your planning. That’s a long time horizon.
Speaking as someone on the back side of the 40-ish hump, I can tell you that it gets much more expensive to do anything close to 10X or 20X your salary for those last 20 years before you retire. Fortunately you dont need it as the kids are out of the house, mortgage is paid off (right?), lots of savings already in place, etc.
My advice: Plan ahead and lock in what you’ll need at age 65 when you are 35 using a term 30. Add in a few shorter term plans as kids are born to cover the “hump” around 40-50 when your spouse will really need the $$$ for college, income replacement, etc, and let them lapse as the kids go out on their own. That’s why I call it a hump: your insurance needs rise and fall in a sort of bell curve centered around 40-45. You could also do a little permanent insurance (maybe 100K max) just so you dont go down to zero at 65+.
Then eat right, exercise, drive carefully, and plan to spend a long life with your spouse!
Evolution Of Wealth says
Funny thing, from my experience, young people hate life insurance until the family comes along. Then they rush out to get it. When the kids move out middle aged people can’t wait to get rid of it. Then you get grandkids. The realization that your life is finite and everything you worked for is right in front of you and do you know what? Older people want to give their kids and grandkids money. They want to have a legacy. It’s too bad they let their life insurance policies go when their kids moved out. It’s a lot hard to get at 75.
Life insurance is always a difficult topic for family and friends to discuss, but a policy that allows dependents to live comfortably for an appropriate amount of time is an ideal plan. Life insurance policies will differ from person to person, which makes is more important than ever to pick a policy that fits your needs.
Moss Life Insurance says
I bought life insurance soon after my son was born, but this post makes me think about buying a little more. It is so important!
Coupon Mole says
I’ll tell you what I hate about life insurance. Having the agents constantly calling you until you buy something! I believe you most likely do not need life insurance until you have kids. And even then it might not make sense. If you can invest your money and make a better return than the insurance companies, then you should invest the money on your own. Of course this won’t help if you die very young.
Personally, I do not own life insurance (yet). I’m still deciding if it’s a good idea or not. I’ll probably put it off till I have kids. The thing that always enters my mind is that the house always wins, and it wins big. These insurance companies are making a killing, which means that most of the people that they insure are paying more than what they get in return. The odds are stacked against you. That’s why I don’t bet on the ponies either.