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Lots of options….choose wisely
There are many types of life insurance. Term, universal, cash value and all sorts of other crazy concoctions that insurance salesmen can come up with to get you to buy their crappy product.
Life insurance is a tool. A tool with one purpose and one purpose only; to give monetary protection to people who will be financially affected should something happen to you.
Life insurance is not for investing. It is not for building up a cash value that they take from you when you die. And it most certainly is not for borrowing against because you are not disciplined enough or forward thinking enough to save and plan in advance.
Term insurance is the only way to go. Buy it early and often. The younger and healthier you are the cheaper it is. I know there will be many of you that will argue with me about these things until you are blue in the face. That’s fine. Let’s just agree to disagree. I am a matter-of-fact kind of person that likes to keep it simple.
Step 1. Crap you don’t want to do and won’t have time to do
So now that we know what kind of life insurance to get, how much do we get?
It’s not rocket science and you don’t have to be Albert Einstein. Figure it backwards. It’s almost like that Algebra class I took in high school is actually useful!
We are solving for X. In this equation X is the size of policy you need to take out.
First, make a list of all the things that your income covers. Think about the extra burden that your absence will cause for your loved ones. This is extremely important if you are married with kids. Will one of you be able to keep the household running smoothly all by yourself? I’m not going to kid myself. I know that if something happened to my wife I would be overwhelmed with running kids around and doing household chores. It would literally consume my life and I would be stressed to the max and this would take a toll on my children, on me, and everyone else I come in contact with.
How much would it cost on a monthly or yearly basis to have someone take care of some of these things for you?
Related: 4 steps to leave a lasting legacy
Think about the state of mind you would be in. You would be grieving immensely. The last thing you want to have to think about is who is going to watch the kids while you are mowing the yard.
The answer is that you are going to watch the kids. You are going to need your kids and they are going to need you. Hire someone to mow the dang grass! I’m not saying that you are completely helpless but there are some things that would make your life a lot easier while you go through the most trying time of your life. Ideally, you will have family and friends surrounding you and helping you but that is not always the case. So after you write down all of those things and the approximate cost you are ready to move on to the next step.
Step 2. Fixed Costs/Essentials
This should be an easy one.
Housing, lights, water, groceries, cell phone, etc. Make a list of all of these things and the monthly and yearly cost. If you are on a budget (you should be) then you should be able to pull up your monthly spreadsheet and see exactly what this number is.
Step 3. Do the Math
I’ve seen some “experts” say that you only need 10 times your income in life insurance. The thinking there is that if you make $50k/year and have a $500k policy, you will invest that policy and get a 10% return and that will replace your $50k/year income.
There are so many things wrong with this school of thought. First off, I don’t want to depend on a 10% return. That’s risky to say the least. My number is going to be much more conservative. More like 6%. If it yields 10% or 15% great! But I’m not betting on it.
Related: Is your emergency fund big enough?
The second fallacy with this thought process is that this is simply income replacement. This does not take into account Step 1. Going from a two parent to a one parent household is an ENORMOUS change. Your world will be turned upside down in more ways than you can imagine. So just for fun lets throw out some numbers to see what this looks like.
This is just an example
Don’t get all worked up that my numbers are not “realistic” or are “ridiculous”. This is just for the purpose of illustration.
First lets say that to live the lifestyle you want once you are on your own it will take an extra $1,000/month. This could be for daycare if one of you is a stay at home parent or to have someone do some household chores or whatever.
Since we are working with even numbers lets say that you need another $5,000/month to replace your take home income. This isn’t even taking into account that you still need to save for retirement, kids college, etc. So altogether you need $6,000/month.
Yearly that comes out to $72,000. As I mentioned above I like the 6% number for return on investment (ROI). You can use whatever number you are comfortable with but I think most educated investors can invest fairly conservatively and easily hit this mark on average. So now you take $72,000 divided by 6% (.06) and that gives you $1,200,000. That may sound like a lot but I like to take that number and go just a smidge higher just to give me a little added peace of mind.
So there you have it. That is how to figure backwards what you need for life insurance.
Is it affordable?
Now how much is that policy going to cost you? Do some research and get a minimum of 3 quotes from different companies. If you are younger (around 30 or younger), healthy and do not smoke I know for a fact that you can get a 20 year policy like this for under $50 per month. That is a small price to pay to make sure that your family is taken care of and just one more thing you can do to leave a lasting legacy.
Now some of you may ask, “Well what about at the end of 20 years when the policy expires? Then what?” Here’s my answer: You’ve got 20 years to get your financial act together so that you are self-insured by the time that policy runs out. If you can’t get out of debt and build a pretty hefty nest egg in 20 years then I’m not sure me or anyone else can help you.
When I am 60 or 50 or maybe even 45 I don’t plan on needing life insurance. I will be what they call “self-insured”. I will have enough money in the bank and other investments that my family will be taken care of.
One more disclaimer. Something is better than nothing. If the policy that you need is a policy that you can’t afford then dial it back. Chances are that you will never need this policy, but having “some’ life insurance is better than having none at all. When you get a better job, or get some debt paid off then go out and purchase another policy to fill the gap.
Tell me your thoughts. Anything I didn’t cover? Do you have any personal stories of people you know leaving their family in a lurch or better yet, leaving their family with a nice big policy that took care of them once their loved one passed on?
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