Over the last few months, I’ve been writing about life insurance. I covered why life insurance is important, the best times to buy life insurance, and the pros of cons of whole vs. term life insurance (the two major types of insurance).
Today, I’d like to cover the basic question that many people ask themselves, “Do I have enough life insurance?” I’ll do that by using myself an example. Everyone’s life situation will be different and your situation will be very different than mine. However, maybe by reading my thought process, you’ll get some insight into what may work for you. As always, I recommend hiring a professional advisor to help guide you through specific personal questions you may have.
With that out of the way, let’s dig in. Time to play, “Do I Have Enough Life Insurance?”
How Much Life Insurance Do I Have?
You answer any “enough” question you need to two components: 1) the amount you have and 2) the amount you need. Calculating what you have is always easy. If you have life insurance, you probably have the paperwork around somewhere.
Because I’m married, I’m going to answer this question jointly with my wife. I personally have $500K of term (20 years) life insurance. It was bought before my oldest son was born. The idea behind it was that if I died, it would comfortably cover child care expenses until he was in college. When we had a second boy nearly a year later, we didn’t make any changes. Raising two children with $500K is not quite as comfortable as raising one, but it’s still a healthy number, right?
My wife has $400K of life insurance through her employer, the United States Health and Human Services. Unlike when we bought insurance for me, we didn’t add more life insurance on her. Why? We were told that adding life insurance on a pregnant woman wasn’t particularly feasible due to possible complications of the pregnancy itself. I don’t know if this is really true, but with $400K under our belt and enough other things to think about (“OMG we’re going to be parents!”) we let that slide.
How Much Life Insurance We Need?
In the previous articles that I mentioned above, the point of life insurance is generally about insuring against financial obligations if you die.
Above, I mentioned two financial obligations, our two sons. (I’m sure they love being referred to as that when reading Dad’s blog years from now.) At ages 4 and 5, we still have a long way to go until they are on their own, but it’s already flying by too fast. On the other hand, we got through the first quarter of raising them. When they go to Kindergarten, child care gets a lot cheaper. With either of our deaths the $400K or $500K goes a lot further now. The $400K, left uninvested, would be $28,500 for the next 14 years, which feels fairly comfortable given our frugal lifestyle.
The other financial obligation we have is our home. We need to pay our mortgage. However, I considering that a “necessary expense” just like, “We need to buy food.” We have a very low interest rate, 2.75% on a 15-year mortgage with about 9 years remaining on it. We are currently paying around $32,000 a year on it. The $400K or $500K could be used to essentially eliminate one of the biggest expenses – a place to live. There’s tremendous overlap between the costs of raising two boys and the biggest expense of a place to live for all of us.
In either case, I can see $400K or $500K being enough to “get to the finish line” with the mortgage and the kids to age 18.
Now this presumes that there would be no other income coming in. I’m not sure that’s realistic. Let’s take the two scenarios:
If I died, my wife would be able to continue to work her 6-figure pharmacist position. In a year, she’s eligible to retire from active duty with 20 years of service as a commander officer, which makes her eligible for a pension. I estimate that to be worth around $50,000 a year. She could retire and work part-time at a local pharmacy for some extra money if necessary. With my $500K of life insurance, she could continue to earn six figures without working much at all until the kids are ready to take care of themselves.
If my wife died, things would be tougher. I don’t know whether there is a pension for suriving spouses who haven’t reached 20 years of service. For that reason, I’ll consider the pension a $0, but when she does become pension eligible, we’ll have an option to insure that pension. This is almost a type of life insurance in and of itself. In the zero-pension scenario, I’d use the $400K as a bridge to get to the finish line (kids become 18 year-olds). I’m fairly frugal which allows me to stretch a dollar further than most people. While blogging and dog sitting aren’t very steady forms of income, I feel fairly confident I can bring in a combined $25,000 a year with them in bad years. I’d actively look for a more traditional job using my computer science degree that would pay a lot better. Right now, I value the flexibility of blogging and dog sitting to support my wife’s career.
This article is already long enough, but I’m leaving out two more pieces of the puzzle. We have some cashflow-neutral investment properties that I estimate will pay around $40,000 a year in 10 years when the mortgages are paid. So that’s another positive. On the negative side, I presumed the kids will not need financial support after 18, which isn’t likely. I think these cancel each other out or lead to a net positive in cash flow down the line.
Based on this, I’m thinking that it would be best to supplement my wife’s life insurance by perhaps buying an additional $500K policy on her. The wild card is the pension, which can make a world of difference. Once I understand the rules around her pension in more detail, I will be better able to decide how much life insurance I would need for income replacement.
The above article is brought to you by Midland National. You can read the latest Midland National News here. These are my own words and thoughts.
If I could do it over again….
1) When the kids were young we bought some 20 year term insurance on my wife. She primarily stayed home with the kids then(though she has a profession), but we knew it would be expensive if I had to provide all of the care for the kids alone. We are only a couple of years from the end of that term. Our original assumption was that it would get the kids to where they were “adults”. Things have changed a lot since then, and it is not uncommon to need to assist your kids longer. Also, my wife’s health has changed and it would be very expensive to buy any more insurance now.
2) We did not buy outside insurance for me because I got great deal on term insurance through my job. Mistake. Jobs change, benefits changes, and as you age that “great deal” turns out to be not so great. At around age 40 we did get a 20 year term policy($500k) on me, but it would have been a better deal to buy it when I was young and for a much longer period.
So my advice is to buy young and buy long.
Lazy Man says
“Buy young and buy long.” I can’t agree more!
Thanks for sharing your experience.
I realize that the kids may not be independent at age 20. I’m nearly 42 and I don’t feel like an adult ;-). I recognize that they may need assistance longer, but my expectation is that our investments will fill the gap.
For pennies on the dollar why wouldn’t you consider paying off the mortgages of those investment properties? Yeah, hopefully no one dies, but with a stroke of a pen while you are both healthy and young you could have paid off investment properties which could act as your “pension”
Lazy Man says
Cheap interest rates, I guess?
Part of my “Lazy Man” moniker comes from the computer science term “Lazy evaluation.” The idea is to delay decisions if possible.
I might need to review the article, as we don’t have the liquid cash to pay off the properties. My intention was to convey that we could use the insurance money to pay off the investment properties and create that “pension”
Adrian - Investor Tuition says
I know I am a finance nerd when I actually enjoy reading about insurance! From the perspective of an ex-adviser turned teacher, there are methods to calculate reasonably accurate insurance amounts. A common one is called the buildup method. This is done by itemizing the different costs attached to one’s lifestyle.
For example, a husband and wife would want to pay off a home loan, provide quality education for their children, and have an ongoing happy lifestyle amongst other stuff. All of this is funded by their income, progressively. Take one income away, (death) and these aspirations would still remain. Therefore you ‘build up’ your final cover amount by estimating all these ‘life’ costs’ brought forward. For example, 1 child with ten years of school to go. cost per year $4,000. = $40,000 added to your total and if you died today your spouse could complete your child’s education as you had planned.
Without getting bogged down, just estimate all your future expenses, current debt, funeral expenses, income production for a spouse unable to work, etc etc. This added up is then your cover amount.
Cover taken out young, when you’re healthy. is far cheaper by the way. And as situations change, you reduce your cover and thus reduce the cost.
And yes the higher the amount of cover, the higher the premium so this has to be factored in. But don’t listen to the idiot’s who scream that the insurance salesperson is just trying to make money. Insurance is needed only when it’s needed. But when it is needed, you’ll be certainly grateful, I assure you.