Life Insurance

Life Insurance is something to consider usually only if you have dependents – others who are counting on you to provide funds for living expenses. If you’re single - without children or elderly parents to look after - there is probably not a reason for you maintain a life insurance policy.

If you do have dependents, seriously consider life insurance if your existing assets are not sufficient to cover expenses for your dependents. Said another, if you do not have literally millions of dollars socked away, you need life insurance (if you have dependents) - the exception being if your spouse’s income covers all expenses in the absence of your income. 

Now that you know whether you need life insurance, you must determine the amount of coverage required. This requires a bit of math. Briefly, consider the cumulative expenses now through the time your dependent(s) will no longer be dependent. If the dependent is a child, this usually means by the time the child has graduated college. Expenses for calculating total life insurance coverage needs usually include utilities expenses, the cost of groceries, clothing allowances, car payments & maintenance expenses, mortgage payments and college tuition. Over the course of 22 years, these expenses can easily total in the millions of dollars. Consider a case study below - wherein one must spouse must provide for their unemployed spouse and a second child who is a minor (age 17).

Income (cash flows) needs for each period - Proposed
	Readjustment (1 Year)	2nd Child Age 17-18	Blackout Period (Age 49-60)	Retirement (40 Years)
Annual Income Needed	$          85,000	$56,667	$                42,500	$            42,500
OASDI (Social Security)	$          37,200	$10,800	$                         -	$            18,000
Net annual income needed (PMT)	$          47,800	$45,867	$                42,500	$            24,500
interest rate	3%	3%	3%	3%
Years needed	1	2	11	40
PV of net annual income needed	$          47,800	$90,397	$429,700.17	$856,597.58
PV of total annual income needed	$     1,424,495

For a complete assessment of your life insurance needs, consider speaking with a financial planner – and not a financial advisor.

Term Life

Now that you have determined how much coverage you need, know that when it comes to life insurance, they are essentially two types of policies: term and everything else. Everything else goes by numerous names, including Whole Life, Variable Life, Universal Life, but broadly is referred to as Permanent Life.

Term life policies are simple and inexpensive – and worth buying. Consider a term life policy similar to car insurance; the car insurance policy will pay out in the event of an accident; a term insurance policy will pay out in the event of death.

Permanent Life

Everything else besides term life is simply not worth the money. To explain, Permanent Life is sold as a combined life insurance and investment product. With a permanent life policy, paying the policy every month means that you’re not only paying your insurance policy, but you’re also investing. However, with a permanent life policy, you can only benefit from one or the other: the life insurance policy or the cash value of your investments – not both. Why? Because there is no way to be simultaneously alive and dead at the same time. So, with a permanent life policy, you’re paying for two benefits, but you only ever receive one benefit.

But there is another catch: fees. When investing via a permanent life policy – as opposed to making your own investments directly – you’re including a middle man that takes their cut – in the form of a sales commission. This means that had you bought a less expensive, more efficient term policy mentioned above, and then invested the difference (BTID), you would have more money to show for it. Why? Simply because there is no middleman.

It’s simple math. When a commissioned financial advisor takes their cut from a permanent life policy, the policy holder is left with less wealth than had they purchased a term policy and invested the difference.

Many are attracted to permanent life policies because they like the forced savings aspect of the product. But there are much more efficient ways to invest. For those without the discipline or knowledge to invest themselves, consider automatic withdrawals to a Vanguard all-one-fund. Each month, money will come out of your checking account and get directed into a low-cost investment for your particular time horizon – or date when you expect to withdraw your money. If you’re still unsure about investing  yourself, speak with a financial planner (– and not a financial advisor).

 

References

Chilton, D. (1998). The Wealthy Barber. Prima Publishing.

Dalton, e. a. (2011). Personal Financial Planning Theory & Practice. USA: Kaplan Schweser.