Good morning (or mid-late morning, or early late afternoon, or late late evening) amigos. Well we did it; we broached the subject of insurance. Getting into this arena leads to all sorts of good, chewy questions (chewy like a delicious Amish-style apple cinnamon oat bake, not chewy like overcooked lamb shanks). We want to address these questions as they deserve; slow and purposeful (like a savory pot of pinto beans, with onions and cilantro… wait a second, I might need to eat before I write this…)
Go and eat your food with gladness. Ecclesiastes 9:7
Anyway let’s dig in. (Couldn’t help it.)
When It comes to life insurance, you most likely fall into one of two camps. Either you’re all jumbled up in your brain about coverage amount, policy types, term vs. whole life, where to title your policy, etc. OR you have no questions at all about insurance and are just now considering that you might need to purchase some. (“Didn’t my employer say I get free life insurance at work? I’m sure that’ll be enough…?”)
My amigo Steven was this way for a long time (he’s, you know, a musician); he didn’t know about this stuff and didn’t want to bother to learn. It was easier to just not think about it. And I know this stuff can feel technical and non-adventurous… but look:
...thus says the LORD of Hosts:
Consider your ways!
You have sown much, and bring in little;
You eat, but do not have enough;
You drink, but you are not filled with drink;
You clothe yourselves, but no one is warm;
And he who earns wages, Earns wages to put into a bag with holes.
Thus says the LORD of Hosts: “Consider your ways!
Haggai 1:5-7
The principle here is that there are many (financial!, according to this passage) issues that are easily passed over, but a diligent man of God puts in the time and energy to master them. We see our job as helping you to those ends, inspiring you and making the arcane easier to lasso.
So come on, cowboy, let’s CONSIDER a bit about insurance!
To begin with, I’m going to provide you a basic framework for how to decide on the key components of a decent life insurance plan for your family. Then we’ll dive into some of the nitty gritty details. If you’re wondering why we are even bothering to talk about something so boring as insurance, then you must’ve missed our first installment, padnah – so go back and read that before continuing on.
Now then, let’s ask FOUR BIG QUESTIONS of life insurance:
Question UNO: Who needs life insurance?
Answer: Anyone who has the need to provide for other people or entities in the event that they are unable to do so in the future, as they would have had they not up and died on us. Most commonly, this means that, if you’re a parent and/or spouse who has not yet banked sufficient dollars to cover the financial needs of your dependents, you should have some life insurance. If you’re on the Abrahamic, territory-expanding journey of stewarding ever-increasing resources, then you won’t always need life insurance. At some point you’ll wake up and say, “Man oh man, you know something? I reckon if I died right now, my wife and kids would just keep on growing this bundle of productive assets I’ve been working on accumulating even while distributing funds to themselves to cover their expenses. Oo-wee.” (Our vision of you is a kind of genteel cowboy wealth manager, a “gentleman rancher” if you will. Go with it.)
An easy back-of-the-napkin way to figure out if you’ve got THAT kind of wealth stockade is to use The Rule of 4%, which many folks consider to be a safe withdrawal rate that will not usually threaten to burn down the principal amount of your savings. So if the assets you’re stewarding are stocks and bonds, your surviving family could take out 4% of their total value annually without risking the principal amount. (Granted, that’s quite a bundle of dough, if a family could live on just 4% of it. Which means… most of us ain’t there yet.)
Of course, if you’re building wealth through other pursuits, like investing in real estate, you may want to carry insurance while you’ve got mortgages on those properties. For instance, if you’re a jack-of-all-trades, playing the roles of landlord, property manager and handyman – your wife and kids might not be so keen on zooming over to the 4-plex to fix a leaky faucet at 10pm on a school night after you kicked the bucket. So it’s best, if you’re planning on resourcing your surviving family, to subtract the income you’re generating now, and allow for a generous margin to be paid to other managers who could make these revenue streams painless for your survivors. (Give them a break, they’re trying to get over the loss of the world’s greatest Dad and husband. The grieving period will be substantial!)
“Yeah… uh… but I don’t even have kids yet, Marko. And my wife and I both earn about the same amount of income – do I really need life insurance?”
Thanks for asking, Chad. You might NOT need life insurance yet! But… there are a couple of possibilities to keep in mind before you poo poo me out of hand:
- One common one is that you’re a small business owner with a li’l group of people. If you die, and can no longer contribute your time and efforts to the business, will it be able to survive? Your partners may want to have a life insurance policy on you that would allow them to buy out your share of the business (presumably from whoever would inherit your assets) for a fair price, rather than having an owner who wasn’t able to participate in the daily operations potentially hamstring the business’ ability to continue to operate. We could write pages on buy-sell agreements, but this is a case when even a childless single person may need life insurance.
- Obviously, this is true for you as well: you might want to have some insurance on any business partners you may have. If they kick it, you can buy out their shares with the proceeds.
- Second-of-ly, you may have a reason to purchase insurance right now in anticipation of needing it later. The older you get, the more expensive it becomes to insure your life. This can be especially true if you run into unexpected health issues. A 24-year-old, healthy young couple thinking about starting a family in the next two years would be wise to consider locking in a 30-year term life insurance policy right now! that will likely provide them a base level of coverage for the duration of their family’s need for insurance. My wife and I bought insurance policies before we had kiddos, while we were young and robust, and we’ll never see those rates again. We’re glad we locked it down when we did.
Question DOS: How much life insurance should I purchase?
Answer: My philosophy, when it comes to insurance, is that it should live up to its name. We’re ensuring that the needs of your family are COVERED in the event of your untimely demise (however that may be). We aren’t setting up a lottery jackpot for your wife and kids.
The people who’re the final word on what policies you qualify for (underwriters) cap the amount of life insurance you can buy. They call this a Moral Hazard limitation, because if your death is a Cash Wad Bonanza waiting to happen for your wife, suddenly her ‘accidentally’ forgetting to double check your harness before sending you down that rappel over Devil’s Cliff during next summer’s vacation seems a little… suspect. (She promises to use some of her newfound millions on grief counseling, so…)
But even with these moral hazard restrictions, you can still buy way more life insurance than you probably need. Think about your monthly budget – just multiply that by 12, and then use the aforementioned 4% rule to figure out what size pile of cash would be necessary to support the family in your absence. Subtract from that any wealth you’ve already accumulated (just be sure it’s accessible – money in your wife’s 401(k) is best left alone until she reaches retirement age lest ye be subject to early withdrawal penalties).
If you’d like to be safe, tack on extra for any debt that you’ve got, and any unfunded goals that you’d still like to fund in your absence (college education for the progeny is a popular one). Let’s use a quick example to be sure you’re tracking with me:
Bob is a 35-year-old father of 3 who earns $95,000 annually and his family budgets around after-tax income of $6500 per month. He is an Abrahamic stud who wants to shore up his family’s provisions with life insurance. Here’s his calculus:
Annual Household Expenses: $78,000
Funds Required to Provide for Expenses: $78,000/4% = $1.95M
So, with just these numbers, he’s looking for a 2 million dollar life insurance policy. But wait! He needs more:
Outstanding Mortgage:$225,000
College Savings Goal: 3x$100,000 = $300,000
Total Insurance Needed: $2,475,000
Are you surprised at the size of that policy? If you haven’t considered such things before, it may seem extravagant. It ain’t.
If we head over to policygenius.com and punch in some generic numbers for Bob, we find that he can purchase a $2.5M policy with a 20 year term for $79/month. If a family with a $6,500 monthly budget cannot find room for an $80 monthly expense, they need to return to our budgeting series. Rinse and repeat until you’ve whipped that budget into shape and made room for an adequate life insurance policy.
Is this overwhelming? I hope not. It’s just applying some simple math to provide for your ranch.
“Ok…”, you’re saying, “When I look at those numbers, and think about what my family needs… I’m feeling a little sheepish about my 2x annual salary group life insurance policy, which is clearly waaaaaaay too small…”
Um, yah. That’s what we do here at The Wallet, homie: we crank your proverbial neck around and make you look at the blind spots. It’s because we love you. Sometimes there are cyclists in those blindspots. Or Runaway tires coming at you. Or people who think you should invest in bitcoin.
But don’t feel too bad: many, many people hear that their employer provides a life insurance policy of some kind and just assume that’s adequate. Rarely do employers cover more than a (low) multiple of your annual salary… and that’s usually far less than a young familybuilder requires in the first decades of their wealth building efforts.
Group life insurance plans (which is what employers offer) also have another hidden barb: they can be very disadvantageous if you leave your job. So even if you opted for extra coverage while at work, and pay extra for it, these plans can involve increased rates that you’ll need to cover if you separate from your employer. Should something change while you’re using that group plan, you could find it hard to purchase insurance privately if you left the company.
Gnarf.
Generally (there are ALWAYS exceptions to these rules gents) it makes the most sense to find yourself a cheap Term Life insurance policy from a good company and not mess around with employer-sponsored plans. Take what they give you for free (Yes! Always!), but consider that to be icing on your insurance cake, not an integral part of your plan.
Question TRES: How long should my insurance policy last for?
Answer: 20 years! It’s always 20 years, next question.
A little financial humor for you right there guys. Ha, ha. Enjoy the shrimp!
Of course the length of term you select for your policy will depend on a slew of factors. I know investment bankers who gained wealth quickly. They might only need 5 or 10 years of coverage before they’ve built up enough wealth to provide for their families in their absence.
Others are going to carry life insurance all the way until they begin collecting social security checks. It’s possible that you’re pursuing a non-traditional career path that could impact your insurance needs. For example, let’s say you’re planning to work until you’re 75 and throw a few mini-retirements in before that age. In this case, you don’t need to be as aggressive with your savings to meet your needs in retirement, but if you die earlier than planned, then your less aggressive savings means you’re not necessarily socking enough dough away to help your family make ends meet without you. That can be remedied by carrying life insurance for a larger part of your life than an aggressive saver would.
In the old days, us financial planners used to help folks create life insurance ladders made of multiple policies. You’d buy a 30 year term policy for $1M, a 20 year $1M policy and a 10 year year $1M policy. The result was insurance that stepped down in coverage (and cost) over time – providing you with $3M in coverage for the first 10 years and only $1M in coverage for the final 10 years of a 30 year period. Nowadays, I’ll often connect my clients with a provider able to create flexible laddered policies, allowing customers to do all of this with a single policy and step down their coverage anytime they wish. Whether you go old school or new school, the point is you’re not likely to need exactly the same amount of coverage from now until you need zero coverage.
Question QUATRO: I’ve heard of life insurance coverage that lasts forever and eventually pays for itself – should I be looking into that?
Answer: What you’re talking about is permanent insurance (whole life insurance and universal life insurance would be the two primary types). It’s a great question. For now, I’ll tell you that, while there ARE situations in which these products are the right tool for the job, we generally advise extreme caution when considering a purchase of permanent insurance. Why? Well you’ll have to read our future article on whole life insurance for that answer! (It’s also a very chewy subject.) (I tease upcoming articles because I care.)
So there were three big insurance questions answered, and one question asked and not really answered, as a tempting bait for future reading.
Lookee there! You just considered your ways for a good 5 minutes! Well done, cowpoke. You honor the Master when you do so.
To sum up, we’ve tried to provide you with a very straightforward guide to deciding whether to purchase life insurance, how much insurance to purchase, and for how long you’ll need insurance. For those of you in that aforementioned, “I didn’t even know I should be thinking about this stuff” bucket, you may feel overwhelmed. No problems homie – just head over to one of the many online sources of cheap term life insurance and get started.
For those in the “I want MANY MUCH MORE DETAILS” camp, you’ll have to wait until our next installment, in which we compare term and whole life insurance, describe when permanent insurance is a good idea, and do our best to not insult your cousin Sal who sells whole life insurance for a living. Until then, keep your spurs sharp, gentlemen ranchers!
*Mark Parrett is one of the founders of Abraham’s Wallet. When not blogging for you here, he’s raising a family in Salt Lake City, UT and working as a financial planner at Outpost Advisors.
