Let’s get this out of the way: it’s only called life insurance to make you feel better. It’s death insurance, folks.
Now that we understand what it’s actually for, what exactly does it do?
And who needs life insurance anyways? Just employees? Stay-at-home spouses? Children?
Let’s go over everyone who may need it, and those unique situations.
What is Life Insurance and Do You Need It?
Life insurance is there to cover expenses in then event that you pass away — not just the expenses of you dying, but mainly the expenses for your family to continue living.
The bottom line: if someone depends on your income or care, you need life insurance.
If you’re single, you probably don’t need life insurance, unless the above bolded line still applies to you.
If you’re not single, you don’t have children, and your spouse works full-time as well, you still may not need much, if any, life insurance. Again, see the bolded line above. And also consider that it will be cheaper for you to get it now, rather than later, so you may want to go ahead and get it before you need it.
You may be wondering “What if my spouse stays home with the children?” In the above bolded sentence, it doesn’t just read “…your income,” it also reads “or care.” Here’s what you’ll need for stay-at-home spouses…
Life Insurance for Stay-at-Home Spouses
Stay-at-home spouses are very valuable. I’ll actually be publishing an entire article on their value next month.
Because of this, you should have life insurance if you are (or are married to) a stay-at-home spouse.
Dave Ramsey suggests taking out a $400,000 policy on stay-at-home spouses, but your situation may vary. You’ll have to determine what you may need to pay for, in the event that they pass away. Here are some things you may need to cover:
- Childcare (if they are the primary caregivers)
- Cleaning services (if they do most of the cleaning)
- Income replacement (if they work from home)
- Accounting services (if they manage your money)
The value of a stay-at-home spouse is significant. Don’t forgo their life insurance policy.
Life Insurance for Children
This isn’t an easy topic to think about, but it is worth making the decision, and then leaving it.
For children, you’re only worried about covering burial costs. Considering that burial costs aren’t very expensive compared to most other death expenses, you should only need this when you’re in the beginning stages of building wealth, and you don’t have the funds to cover the costs. However, it will be so cheap, you might as well keep it.
For one more reason to buy life insurance for your children, it can help them qualify for more affordable plans, if they continue a life insurance policy on themselves once they’re old enough to worry about it.
The Types of Life Insurance
There are a few common types. The two basic types are “whole life” and “term.” One is for your whole life, and the other is for a certain term. Can you guess which one is which? There are other types of life insurance, but they’re largely just variations of whole life, and we will cover them as well. Here’s the breakdown:
- Whole Life – Whole life is appropriately named, because it is for your whole life. The premiums are generally pretty high, since they are, to an extent, guaranteeing to insure you for the rest of your life, for better or worse. Whole Life policies carry a “cash value”, which is what makes it
an awesomesomewhat of an investment.
- Term – Just like it sounds, term policies provide coverage for a specific term (usually no more than 30 years). Term insurance is usually much cheaper than whole life, but that’s because the coverage isn’t forever. Each term gets more expensive as you age. Ideally, you wouldn’t need life insurance by the time your terms ends.
- Universal Life – As a form of whole life, universal life is a more flexible option. Your insurance coverage and rates can be adjusted based on your needs and changes in your situation. It simply gives more flexibility.
- Variable Life – As another form of whole life, variable is meant to be even more of an investment. You still have your cash reserves building up, but you also have a portion of your cash being used for investing in different things, from conservative money market accounts to bond and stock mutual funds.
- Variable Universal Life – This is exactly what it sounds like: a combination of universal (more flexibility in your coverage) and variable (more investment options). Variable universal gives you a lot of options, which can be a good or a bad thing.
The choices may seem overwhelming, but it’s easy to choose life insurance when you understand that life insurance should not be an investment. If you want to invest, there are plenty of good options out there. Life insurance isn’t one of them. However, if you plan on keeping life insurance for your whole life (we’ll discuss why you shouldn’t in a moment), then you may want to go with a whole life policy to make sure you always have coverage. As far as whole life vs. term insurance, that’s quite a debate.
There are primarily two sides to the life insurance debate in the financial world:
- The probably more old-fashioned side says to get term. Term is cheaper than whole life, so you would invest the difference that you save (in an HSA, perhaps), and you would come out ahead. Dave Ramsey suggests this approach.
- The other side is that you should get whole life, because “nobody ever really invests the difference anyways,” and it provides more coverage for longer, generally speaking. A research study popularized this second view.
Between those two arguments, I’m still inclined to go with term, because you should never do something financially based on the fact that you “probably won’t do something else.” I get the idea of making things easy, and automatic, but if you decide to do something, discipline yourself and do it. Another reason I prefer term is because you shouldn’t be looking at life insurance as a permanent (whole life) solution. You should only need it for a “term,” until you can afford to do what life insurance does.
How Much Life Insurance Do You Need?
Regardless of which form you go with, how much coverage should you get?
Well, the basic idea here, and the most commonly taught idea, is to multiply your annual income by 10 and get that much. That’s an easy formula that sounds made up with no real data to back it up (and it probably is), but it works well enough to determine coverage.
I would always err on the side of caution here. It is insurance after all. Caution is what it’s for. There are some things to consider other than the 10x rule, but if you really don’t want to worry about calculating it (it takes two minutes), you can always just stick with the 10x rule. It’s better than not having life insurance. You really don’t need a fancy life insurance calculator. You can easily determine your life insurance needs with some basic math. Here are some guidelines:
- An ongoing salary after you die. If you earn 50k/year, and you want your spouse to continue getting that, you will need a policy that pays enough to conservatively invest and earn that income. So for a 50k salary, you would need to invest $1 million at 5%(fairly conservative rate) to receive an annual income of 50k. So you would start with a $1 million policy.
- Any debts you will still owe. If you have a mortgage, auto loans, and other debts, you will want enough to pay them off when you die. So if all other debts total $300k, you will need an extra $300k in your policy.
- Children’s college funding. If you’ve decided to pay for your children’s education, and you don’t have another form of investment that is going to fund that, then you will need to include this in your life insurance payout. For this example, let’s assume you want to include $100k per children, and you have two children.
- Death expenses. Finally, include expenses like burial costs and funeral services. Compared to the rest of the policy, this won’t be much. We’ll say, for this example, that it’s an extra $20k. That means that this total policy would be $1,520,000.
It’s easy to calculate when you think about it. All you’re doing is making sure your expenses are covered and covering the salary you currently earn. That being said, you can always cut your life insurance down to be more conservative, knowing that your spouse’s standard of living would go down if you passed away, but I don’t recommend this. If you’re young, life insurance isn’t that expensive, so I would again err on the side of caution. It’s better to get too much than not enough.
When You Can Drop the Life Insurance
Life insurance doesn’t have to be forever. In fact, if you practice good financial habits, you shouldn’t need it forever. There will come a point when you have enough money in emergency savings and investments to drop your life insurance, or at least drastically reduce it. This should be right about the time that life insurance is starting to get much more expensive. So it works out.
The bottom line: you can drop your insurance once you’ve acquired enough wealth to be able to cover the expenses of your family, in the event that something happens to you. This may mean having enough for your spouse to be able to live on the interest.
If something happens to you, the last thing your spouse wants to worry about is changing her entire lifestyle. At that point, you being gone is hard enough on the family. If you can’t afford to keep your lifestyle without you here, keep the life insurance.
If you’re not sure, keep your life insurance.
Do you have life insurance? Which type of policy is it? Share below!