One of the most important insurance policies I have is my 20 year, $1 million term life insurance policy. I took it out on my 35th birthday because before then, I had life insurance through my employer based on 4X my base salary. As many of you know, I left Corporate America in 2012 at the age of 34.5 and now have to pay for all of my own insurance. Cherish your work benefits folks!
The reason why I have life insurance is because I have mortgage debt. If I ever have kids, then I’ll probably increase my coverage even further. In case of early death, I don’t want those who inherit my assets to feel any financial burden.
I’ll use my own example and share other examples as well to help you better understand the life insurance process. This post will go over:
- When to get life insurance.
- How long of a life insurance term to get.
- How much life insurance to get.
- A sample chart comparing costs based on different amounts and terms.
- Where to get life insurance.
WHEN TO GET LIFE INSURANCE
The general recommendation is to get life insurance when you are younger, so you lock in a lower fixed price. Once you have a policy, you can alter your policy based on your changing needs. But the reality is everything is priced in. Since you’re younger, you’ll pay less per month, but you’ll pay for more years than someone who takes out life insurance at an older age.
As a result, it’s much better to get life insurance once you either take on a lot of debt, have a newborn, or both, instead of by a predetermined age.
Here are the main questions you should ask before getting life insurance in the first place.
- Do I have people depending on my income to survive? A non-working spouse, children, and retired parents who need financial support are the most common dependents.
- Will my debt be a burden on those I leave behind? The most common type of debt is mortgage debt. Other important debt to consider is high interest consumer debt. The larger your debt and the smaller your equity, the wiser it is to get life insurance.
- Will I die early or before my dependents have a chance to become independent? Males die earlier than females. Meanwhile, if you have a history of health problems, you will likely die earlier than those dependent who are healthier. You know your body the best, even more than the health tests administered to those who get $1M policies or greater.
If you answered “YES” to any of these questions, then you should get term life insurance. Now the question is, for how long and how much?
HOW LONG OF A LIFE INSURANCE TERM?
Given the largest debt for most people is a mortgage, it’s a good idea to match the life insurance term as close as possible to the years remaining on paying off the mortgage.
For example, I’ve got a $960,000 mortgage that has 22 years remaining until it gets paid off based on its amortization schedule. As a result, I took out a $1M, 20-year term life insurance policy to cover this debt just in case I die early. The annual mortgage payment is roughly $53,000 a year ($26,000 goes to principal) along with a whopping $21,000 a year in property taxes and $2,000 a year in home insurance cost.
In other words, if I die, the person who inherits this property will have to pay $76,000 a year to own the house plus inevitable maintenance expenses. That’s a lot of money if you don’t make at least $150,000 gross a year. The person whom I’m leaving the property to currently does make over $150,000 a year, but one day she might not, and I don’t want my death to have a psychological + financial burden on her.
Another way to think about your duration matching is to think about how long it will take for you to pay off all debt. Given I plan to pay off all debt by the age of 60 (in 22 years), having a 20 year term life insurance policy is about right.
HOW MUCH LIFE INSURANCE TO TAKE OUT?
Although I have more than $960,000 in debt since I have a couple more properties with mortgages, I’ve decided to just pay for a $1M, 20-year term life insurance policy for the following reasons:
- If the property with a $960,000 mortgage is sold, there is a high probability that there will be greater than a $1,000,000 windfall because the property is worth anywhere between $2,000,000 – $2,800,000.
- The person who inherits the property currently makes over $150,000 a year, and will also inherit my business, which also makes over $150,000 a year. In other words, she has the cash flow to be able to float the property for years.
- I secretly don’t think I’ll die within 10 years, and hopefully not within 20 years either! But that’s what everybody thinks who takes out life insurance. I’ve already decided to pay ~$540 a year for life insurance premiums I don’t believe will be used. I’m not sure I’m willing to spend more at this moment. Each year I live, at least $50,000 in debt is automatically paid down.
Here are some options for you to consider in terms of how much life insurance to take out.
Most conservative decision: Take out as much life insurance as possible to completely eliminate all debt plus provide money left over to pay for living expenses for the rest of your dependent’s lives. Use a life expectancy of age 100. Take 100 – current age and multiply by annual living expenses e.g. $500,000 debt + 50 years X $100,000 = $5 million term policy.
Conservative decision: Take out as much life insurance to completely eliminate all debt plus provide enough living expenses until the age of 70 when full Social Security benefits get paid e.g. $300,000 debt + 30 years X $80,000 = $2,700,000. Round up and get a $3 million term policy.
Moderate decision: Take out as much life insurance to eliminate all debt and provide for 5-10 years of living expenses, long enough for your dependents to become independent e.g. $500,000 debt + $100,000 X 10 = $1.5 million term policy.
Least conservative decision: Take out just enough life insurance to make sure any assets inherited don’t become a burden. The life insurance should give the recipient enough time to decide what is best to do with the receiving assets. This is my case where the recipient of my house can decide to live in the house, rent out the house, or sell the house to extract the equity.
Riskiest decision: Of course, the riskiest decision of all is to not take out any life insurance when you have dependents and debt. Even if you don’t have debt, having life insurance is important for income purposes. If you have no debt and no dependents, then getting life insurance is probably a waste of money unless you feel you have a greater chance than normal you’ll die before the people you care about and want to provide income for them.
Check out the chart I put together based on how much each life insurance policy would cost by term and amount.
THE MOST COMMON LIFE INSURANCE POLICY
Based on my conversation with various insurance companies, the most common life insurance policy is for 25 years and $250,000. That makes a lot of sense given what we know about median household income and median net worth. Twenty-five years also should be enough to cover the expenses of raising a child from birth to adulthood.
If you ever want to get some motivation to live a healthier life, speak to a life insurance agent or get a life insurance quote. They’ll ask the following questions:
- History of significant medical conditions, cancer, diabetes, heart disease with you or your immediate family.
- Whether you’ve used tobacco or other substance abuse products in the past 12 months.
- How much alcohol you drink a week.
- Whether your mother or father have died before 60 due to cancer or cardiovascular disease.
- Your cholesterol and blood pressure. You’ll have to go for a physical at an approved medical center to get your bloodwork etc. Or, they’ll come to you if you are getting a large policy, usually over $1M.
WHERE TO GET LIFE INSURANCE?
Thinking about death is always a sobering topic. However, knowing that my loved ones will not only get my assets, but a nice $1,000,000 tax-free check from my insurance company really makes my day. Getting life insurance really does help the psyche.
One of the easiest places to get multiple term life insurance policy quotes in one place is PolicyGenius. You don’t really know how good your life insurance quote is if you inquire directly with one insurance carrier. Because life insurance prices are regulated, you should use a tool to help you compare costs easily.
As I come to the end of this article, I realize that having only a $1M term life insurance policy is a little too conservative because I want my dependents to continue living a fantastic life long after I’m gone. All I’ve done is cover a large chunk of my debt, without considering extra money left over for living expenses.
Updated for 2017 and beyond.