The Right Amount Of Life Insurance
If you haven’t done so already, calculate your net worth to assess how you did this past year. Hopefully, you’ve grown your net worth, despite the stagnant stock markets through aggressive savings, retirement company matches, a diversified investment portfolio, rental property cash-flow, and an increase in your start-up’s value.
Wait, all you have is your savings? Then you better start diversifying your income stream so you’re always moving forward, no matter how rough the economy. Once you’ve calculated your net worth, make sure your life insurance levels equals this amount, especially if you have dependents, or a spouse who makes much less than you. If you die, and want your loved ones to maintain a similar standard of living, consider matching your life insurance amount with your family’s net worth amount.
Some might not agree with this life insurance guideline and wonder whether it would be better to have insurance that equals a family’s debt level only. Having enough life insurance to pay off all of your family’s debt is better than no life insurance at all.
If you’re single and have no dependents, do you really need life insurance? Probably not. If you die with a million bucks in debt, you’re living large!
Consider the Robinson family in San Francisco with two children ages 8 & 7:
* Wife (35) Income: $200,000
* Husband (34) Income: $60,000
* Savings Rate After Tax: 30%
* House Value: $900,000
* 401K/IRA: $500,000
* Cash: $100,000
* Personal Stock Portfolio: $100,000
Total Assets: $1,600,000 + $45,000 a year in savings each year they work.
* Recurring Private Education Cost: $25,000
* Mortgage: $500,000
* Consumer Debt: $20,000.
Total Liabilities: $420,000
Net Worth: $1,090,000 – $30,000 a year for the next 15 years as their two kids finish high school and go to college.
Take a moment to consider the Robinson’s family situation. How much life insurance should Mr. Robinson take out, and how much should Mrs. Robinson take out?
Mrs. Robinson’s Situation
Mrs. Robinson is clearly the breadwinner of the family. If her income disappears, it’s up to Mr. Robinson to take on the $420,000 debt level, which is 7X his annual income. Furthermore, after taxes, Mr. Robinson will only have about $42,000 left over, barely enough to cover the $30,000 a year in tuition! In this scenario, is a $420,000 life insurance policy enough? Probably not, since even after all debt is paid, Mr. Robinson would have to spend the majority of his salary on his kids tuition, buffered by the $100,000 in cash savings he can use penalty free.
With a $1,100,000 life insurance policy, Mr. Robinson can breathe much easier as he can use $420,000 to pay off all debt and have $670,000 left to pay for his kids education for 20 years and maintain his living situation without further disrupting his family.
$1.1 million happens to be 18X Mr. Robinson’s income as he is living larger than his income could allow on his own.
Mr. Robinson’s Situation
If Mr. Robinson dies, the financial hit is not as great given his $60,000 gross income. Mrs. Robinson’s $200,000 gross income can pay the $30,000 a year in tuition, an estimated $30,000 a year in mortgage costs at a 4% interest rate level, $10,000 a year in property tax, and $30,000 a year in food, clothing, and travel with $20,000 left over.
$20,000 left over for savings is still good, but will there really be $20,000 left over if Mr. Robinson is no longer around? Unlikely, given Mr. Robinson had very flexible hours and was able to care for the kids while she worked late and sometimes on the weekends. Mrs. Robinson needs help as a single mother, and the $20,000 goes towards paying for help.
Given Mrs. Robinson makes $200,000, she should have no problem paying the extra $50-$100/month for a $1.1 million life insurance policy vs. a $420,000 life insurance policy. $1.1 million equals 5.5X Mrs. Robinson’s income.
THE RIGHT AMOUNT OF LIFE INSURANCE
When you lose a spouse, the last thing you want to do is have more disruption due to your finances. Are you really going to pull your kids out of school and away from their friends after their mother or father just died? No. The surviving spouse will be in mourning, and needs that life insurance policy as insurance that he or she can have as much time possible to figure things out.
If necessary absolutely necessary, the surviving Robinson parent can sell all assets to cover all liabilities and net roughly $1 million in cash after fees. However, the family still needs a place to stay and go to school.
It’s foolish to be underinsured to save a nominal amount of money every month. $420,000 worth of life insurance is better than zero in the Robinson’s case. However, it’s best to simply match the life insurance amount for each spouse to the estimated net worth of the entire family.
* At a minimum, take out enough life insurance to cover all liabilities.
* Consider taking out enough life insurance to match your family’s estimated net worth.
* If you’re estimated net worth is small, consider the cost of getting life insurance equal to 5X-10X the highest income earner.
* Check your company policy. Many employers will offer anywhere from a 1-5X base salary life insurance multiple. If you want more, you just have to elect and pay.
* Protect your assets by taking out an umbrella policy, which covers liability beyond your car and house insurance policies.
* Shop around for health insurance: The internet has really helped lower the cost of insuring yourself and your family. eHealthInsurance has some of the lowest rates and best coverage due to its largest network. They are based right here in the Bay Area, and I have met a number of their representatives. The Affordable Care Act debacle has proven to be more expensive and more cumbersome to sign up so far.
* Get the best home insurance possible. In order for your property to grow in value you must protect your property from damage. Fires, floods, leaks, theft, and other accidents happen all the time. If you have cut-rate insurance, you could very well pay way more than you should. I highly recommend checking with USInsurance.com online to find the best home insurance rates. They have a huge network of providers that will compete against each other to provide the most tailored home insurance coverage possible that is affordable. Mobile home insurance, renters insurance, condo insurance, and homeowners insurance are just a few of the options based on the type of home in which you reside. Leverage the internet to save money and protect your largest asset.
Photo: Empty inner-tube, Kahala. SD.