Life insurance is a good idea if you are still on the path to financial independence. If you have debt and dependents, getting life insurance is a no-brainer. But do you still need life insurance when you're financially independent, rich, or retired?
To answer this question, we must first define what financial independence means and how it relates to one's life insurance needs. Then I'll discuss various levels of financial independence to determine whether getting life insurance is appropriate or not.
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Defining Financial Independence
You are financially independent when your investment income covers 100% of your desired living expenses in a risk-appropriate way.
Having your stock portfolio go up 40% one year and crash 30% the next year is probably not risk-appropriate. It's hard to calculate a proper safe withdrawal rate.
As a result, diversify your passive income investments. This way, you'll always be able to have a steady retirement income stream, no matter how bad things get.
As someone who is financially independent or retired, you can construct your net worth in various ways with debt or without debt.
Ideally, you want to have less debt or no debt when you no longer have the desire to earn income actively. This includes earning supplemental retirement income.
Since you are considered financially independent, I wouldn't recommend having debt greater than 5X (3X preferable max) your annual income or 20% of your net worth.
In other words, if you have a $100,000 annual income, keep your debt load to $300,000 – $500,000. Or, more conservatively, if you have a $1 million net worth, keep your debt load to no more than $200,000. This way, debt will have a difficult time derailing your retirement plans.
Some believe that getting life insurance when you're financially independent is completely unnecessary. After all, you're financially independent with all your expenses covered.
However, let's look at the various levels of financial independence to determine whether this may be true or not. Not all types of financial independence are equal.
Levels Of Financial Independence To Determine Life Insurance Needs
Here are the main ways I would categorize financial independence for life insurance purposes. Yes, even if you are rich, life insurance can be appropriate.
1) Financially independent without debt and no dependents.
In such a scenario, life insurance is unnecessary. When you die, your estate goes to whomever you indicate in your will or revocable trust. There are no debts to settle or dependents to take care of. Your estate can pay for all lawyer fees, taxes, and anything else.
2) Financially independent without debt and WITH dependents.
In such a scenario, life insurance is encouraged, depending on the maturity and capacity of your dependents.
For example, let's say your dependents are children under 10. You may want to get life insurance when you're financially independent with young children and no debt to provide further financial security until all financial matters are settled by the trustee. The same thing goes for those of you who have a dependent with a disability.
Hopefully, you've set up a revocable living trust with a capable trustee who will help handle your estate after you pass. When it comes to dependents, you want the absolute best for them if you were to pass before they become independent.
3) Financially independent WITH debt and NO dependents.
In such a scenario, life insurance is less necessary than if you are without debt and with dependents. Given you are financially independent, your debt can easily be settled by covering interest payments until the debt is paid off or by selling an asset.
With no dependents, death is easier. You don't have to worry about how your loved ones will survive after you are gone. Everything that goes to your beneficiaries is just bonus money for them.
4) Financially independent WITH debt and WITH dependents.
Finally, we come to a financial independence scenario where getting life insurance is encouraged. I see many early retirees in this camp. This would be considered the lowest level of financial independence as it relates to life insurance. This is where my family finds ourselves currently.
People who are financially independent with debt and dependents simply have more at stake. Their net worth composition is likely more complex. Therefore, more time will likely be needed to settle estate affairs.
There also may be more tax events required to settle debt. For example, your net worth might be comprised of rental properties with mortgages. Perhaps after you die, your heirs would like to sell a property or two and reinvest the proceeds. As a result, having life insurance is a nice option to cover estate-related costs.
Depending on the age, maturity, and capacity of your dependents, life insurance can provide for a long enough period of time to prevent any drastic changes in your estate.
Life insurance also helps protect dependents if there are negative changes to various investment income streams, e.g. tenants stop paying due to a job loss, corporate dividends get cut due to a recession, a natural disaster causes damage to assets, etc.
When you have dependents, you want to provide as much of a financial cushion as possible to minimize further disruption in their lives. Dealing with a parent's death is already hard enough.
Life Insurance If You Are Real Estate Heavy
If your net worth and retirement income largely consists of real estate and rental income, then getting life insurance is more worthwhile.
One of the biggest downsides of owning real estate compared to owning stocks is real estate is more complicated. Real estate costs more to sell, takes longer to sell, may be harder to collect income, and is subject to natural disasters.
Ideally, after you pass, no real estate needs to be sold from your estate. If you have a small mortgage or no mortgage, your estate should easily be able to pay ongoing maintenance, insurance, and property taxes. However, you just never know for sure.
If real estate or rental income is more than 25% of your net worth or retirement income, I would get life insurance.
Personally, real estate (including real estate crowdfunding) now comprises roughly 40% of our family's net worth. Therefore, until we get the percentage below 25%, by hopefully growing our overall net worth, we are happy to have a life insurance policy.
In addition, if you have a mortgage, I would get a life insurance amount equal to at least your mortgage amount. If you don't have a mortgage, then the life insurance amount will depend on your dependent's living expenses and the time it takes to get your estate affairs in order.
Life Insurance And A Complicated Net Worth
The more complicated your net worth, the more you should consider getting life insurance.
Between my wife and two kids, we have over 35 financial accounts. Therefore, our family's net worth composition is complex. If my wife or I, or both of us were to die, gaining access to all our financial accounts will take a long time.
We do have estate plan documents with detailed instructions. However, going through our finances in detail will be a first for all trustees on our list. It's the same for almost all trustees since most people don't share all their financial details outside of their household.
It would be one thing if all our retirement income just showed up in an envelope full of cash each month. However, our retirement income comes from multiple sources that hit multiple banks and financial accounts.
Even with detailed instructions on how to collect all the income, access all financial accounts, and distribute all assets, I'm sure there will be some roadblocks on the way.
If your household has more than 20 financial accounts, I would consider getting life insurance. Further, if your investment holdings have multiple cross-structures and owners, getting life insurance also makes sense.
Related: All Life Insurance Options To Choose From
Life Insurance Provides Quick Access To Cash
Getting life insurance buys time for trustees to execute estate wishes. Life insurance enables your estate to go through the least amount of disruptions as possible. It may take your heirs a long time to untangle the web of assets left behind.
Let's say you pass away unexpectedly. Your trustee can't gain immediate access to your financial accounts even if they know your password unless they are a joint account holder. Everything needs to go through your estate and follow proper procedures. This takes time even if you have a solid estate plan in place.
Fortunately, your life insurance beneficiaries and/or trustee can gain quick access to your life insurance payout baring any claim disputes. This can help immensely for your loved ones to settle payments for funeral arrangements, medical bills, or other immediate needs.
Life Insurance And Estate Taxes
If you are financially independent, there's a higher chance your estate might surpass the estate exemption amount threshold. If so, your estate will have to pay ~40% for every dollar over the limit.
For example, let's say Joe Biden lowers the estate exemption amount to $3 million per person from $11.7 million. If you leave an estate worth $4 million, your estate will have to pay a 40% tax on $1 million ($4 million – $3 million). Life insurance will make it easier to pay the $400,000 estate tax liability.
To avoid paying any estate tax (death tax), while living, it'll be up to you to spend or give away money until your estate is under the threshold. You will also have to successfully forecast the estate tax threshold when you die.
Two Main Life Insurance Considerations Regardless Of Your Financial Situation
When you have dependents, much of what you do revolves around ensuring their survival until they become independent. Therefore, paying for life insurance doesn't feel like a waste. It feels like a necessary expense.
Regardless of your financial situation, the easiest two things to consider when getting life insurance are:
1) Get enough life insurance to pay off all liabilities. This way, you minimize your dependents risk of losing key assets. For example, let's say you have a $400,000 mortgage on a $1 million house. Despite the tremendous amount of equity, your lender could default on your house if you stop paying the mortgage after a while.
2) Get enough life insurance to cover all your dependent's needs until they become adults. Take the number 18 minus your child's current age to get the shortest term life insurance duration. However, you might not think your children will become independent adults until they are 25. Therefore, your life insurance term may be longer. You know you children best.
Let's go through an example of a financially independent family with kids.
A family of 4 has $5 million in assets and $1 million in liabilities. There are 20 years remaining on the mortgage amortization period. Kids are ages 7 and 5. Dad and mom are 40. Their passive income is $150,000 a year. Expenses are $100,000 a year.
Each parent can get a $1 million term policy for 15 years. In 15 years, both kids will be adults. Further, the $1 million mortgage will likely be less than $250,000, if not $0 after 15 years. Therefore, the parents timed their life insurance needs perfectly.
Two Goals For Parents With Debt And Dependents
My wife and I find ourselves in a situation where we have debt and dependents. We don't have enough cash on hand to pay off our mortgage debt. The only way to pay off debt would be to sell assets, which would then trigger tax liability. Therefore, we both have life insurance.
When my wife was able to double her life insurance coverage for less than what she was previously paying to match mine in 2020, I did experience some relief. It made no sense for us to have mismatched coverage amounts given we are equal partners to our children. I'm glad COVID-19 didn't prevent her from getting more coverage.
If you are finding you are unable to get affordable life insurance or reluctant to get life insurance, then you have two goals.
Goal #1: Get healthy, stay healthy, live another year. Each year you live is a win. The news during the pandemic reminds us of this fact every day. From a life insurance perspective, you can quantify one year of life as equal to the annual life insurance premium amount.
Goal #2: Create more wealth equal to your liability. For example, let's say you have a $1 million mortgage and can't get affordable life insurance. Your goal is to make an additional $1 million net worth before you die.
Once you have no debt and your kids are on their own way, life insurance is no longer necessary. However, in the meantime, you might as well work on these two goals.
With my goal to re-retire once everybody I know gets inoculated, I've got about one year to build as much wealth as possible to match my policy coverage. Thankfully, if I fail, I've actually got more time as my $1 million term policy expires on January 5, 2023.
Minimize Complications With Life Insurance
As I've gotten older, more people I know have died. In many cases, the transfer of assets took a while and did not go smoothly. If it wasn't a lost password or missing documentation, it was the retirement of the estate planning lawyer who set up the deceased person's trust. Something always seems to go wrong.
Use the framework above to decide whether life insurance is necessary. Like all things in personal finance, you have to make decisions that meet the needs of your family, financial situation, and lifestyle.
Life insurance gives me more peace of mind. And to me, peace of mind is worth a lot. Now it's time to go exercise and eat lots of vegetables!
Related: Why The Best Age To Get Life Insurance Is 30
Readers, do you believe life insurance is necessary if you are financially independent or retired? If you can get affordable life insurance while you still have dependents or debt, why wouldn't you, regardless of whether you are financially independent or not?
Shop Around For Better Life Insurance Today
My favorite way to find affordable life insurance is through PolicyGenius. PolicyGenius will help you find the best plan for the lowest price tailored to your needs. PolicyGenius provides free, no-obligation quotes in one place.
In the past, you would have to get a life insurance quote by applying to individual carriers – the process was completely opaque. Now, you can have multiple qualified life insurance carriers compete for your business.
Over time, your life insurance needs will vary. Stay on top of it so your family is always protected. During the pandemic, my wife was able to double her coverage for less money with PolicyGenius. We are very thankful for their ability to help us compare competitive quotes.
We have 3 mortgages. In my country the banks require you to pay insurance on the mortgage, so in case you die, the mortgage is written off. it add about 5% to the monthly cost, but as it is taken away automatically you dont even feel it.
We recently started a college saving account in a mutual fund, and it also covers you up. in case of disability or death, college will get paid, at least 70% of it which was our goal.
We pay our own medical insurance, so im covered on that front.
But the cost of all this adds up.
So im now thinking in starting a savings account for my own retirement which also includes a disability insurance, so in the case you cannot work anymore, you get paid.
My question is this: how much of your monthly income should go to paying insurance, in terms of percentage.
Similar to real estate, for us it is the cash flow needed to cover daycare on two kids for a few years that makes me thankful for the employer-provided life coverage we get.
Assets could of course be sold to easily cover this, but why mess around with the tax implications and forced sale.
I have enough life insurance to pay off our mortgage. I got a small policy when I quit working full-time. It might be time to shop around. I can probably get a better deal now.
As for the cost of raising a child, I’m not too worried. Our trustee can sell off some assets as needed.
My wife has a bigger policy through work. That will go away after she retires. I’m not sure if we should get a new policy for her or not. Probably not.
I had posted a similar question in a previous Life Insurance post so I appreciate the thoughtful points of view and detailed response. While we have dependents (10 & 12), we have no debt, a fairly straight forward financial account situation and a living trust so I feel OK not paying for life insurance at the moment. If our situation changes (ie: realestate or new debt) I’ll definitely keep these points in mind.
I finally got rid of my life insurance. We figured we had more than enough to cover anything including any unknown medical needs that could arise. We keep this money in cash currently earning .2 percent. There’s enough cash to last 5 years no matter what comes up. The account is in my and my wife’s name at our local bank. Financially speaking, it’s a suboptimal move leaving that much cash on the sidelines doing nothing but I rationalize it buy telling myself I’m saving on insurance premiums which boosts my .2 percent return on our cash.
Sure, do what’s more comfortable for you. At the same time, it’s worth quantifying the cost by checking the latest term life insurance rate. This way, you can have a figure in mind to objectively compare whether the cost savings is worth it.
My wife found out 8 years later she was overpaying for her policy just by checking online. She thought she was getting a great rate with USAA, but I told her one day during the pandemic that $65/month for $500K and 25 yers didn’t feel like good value b/c my $1M term was for $49, even though it was only a 10-year term. So she upgraded to $1M and STILL lowered her monthly premiums.
So for us, paying $600/year for a $1 million, 25-year term felt like great value. Peace of mind for covering our kids until they become indepenent. And we can always cancel earlier.
You just never know. I think life insurance rates have gone down during the pandemic with more demand.
No need to earn only 0.20% on your cash. Try Marcus bank or american express online bank. I think they pay 0.40% or you can buy a CD, although these rates are low. Or you could accept slightly higher risk and invest in a high grade corporate bond fund (EFT) such as VCSH. Yes slightly more risky. Yield > 2%. still not a great yield but since this is high quality short term corporate debt it has less price risk (its has shorter duration and less credit risk)
Bill
I have similar views on Life insurance!
No need to give away money to a company that will likely use its lawyers to work against your widows best interest if the time comes for it to be cashed in.
I do pay for survivors benefits through my military retirement and will likely do the same for my federal retirement when the time comes.
If my wife should pass away before myself I will not need to have her pension or SS for my survival so we do not plan to have her maintain a survivors benefit plan.
We have similar cash holdings in joint accounts as you describe for that eventuality!
Those accounts double as our long term care facility fund as well!
It also provides us with capital holdings used to determine loan eligibility!
So although it does not provide a significant passive income stream it does provide for financial security and freedom from any fear or anxiety that future market conditions might bring upon us.
Peace of mind to weather through another downturn and future health issues is more important to us than the potential to earn an additional 4-10 thousand dollars a year if that money were invested elsewhere.
I am a bit slower than most and never rationalized the added value of this plan by saving on both long term care insurance and life insurance!
Thanks for pointing this out, it makes me feel more intelligent today than I thought I was yesterday!
Regards
Chris
‘Live another year.’ I love it I am lying in a hospital bed w heart issues. Living another year is a good idea to me. I was walking around and fell to the ground. Now, I have many wires attached to me.
As I lay here, it is a relief knowing my family is financially ok. No worries. But I agree, it makes sense to live one more year.
Get well soon Charles. Hold on strong as we’re under 8 months away from better lifestyles again. Let’s all live long enough to enjoy the new normal!
Charles, I don’t know you but just said a prayer for you. Keep fighting and know that there is a higher power watching over you with an abundant supply of healing grace and mercy. Just ask for it!
Best wishes for you and your family. Hopefully you are out of the hospital at this point.
How much do you recommend your net worth should be before you need life insurance?
I don’t think its really about net worth ratio. I think it’s more what is your liability that you need to cover if you expire. What will it cost to pay off all of your debts, and to replace your salary to dependents and loved ones for a certain duration.
So first step, is to figure out what you owe tomorrow, if you expired today. Start with what is needed and then go from there. You can always swing for the fences and get something crazy like a $3M policy (crazy depending on current debts), but then you run the risk of your family plotting an accident. Your death ideally shouldn’t be a windfall for them. It should cover the loss of stability during trying times.
Safest, is to get enough to cover all debts and projected costs for a set duration (10 years – 20 years), and then likely not tell your family what the real value is. You don’t want them calculating your worth to them, and certainly don’t want to be worth more dead than alive.
I’d have to agree with this. The policy amount covers some or all of your liabilities. The term amount covers the years until you think your kids will become independent or until your debt is paid off.
I like going a little more conservative on both.
Great points. I had definitely not considered life insurance any longer since leaving my job (where they provided a smoking deal). But this definitely gives me something to consider. I like the idea of life insurance effectively paying down all debt and/or making any issues that crop up much easier to deal with.
Really good points on the benefits of life insurance for those with complex finances and a lot of different financial accounts. I plan to keep my life insurance policy for at least another 20 years to protect my kids. My premium is reasonable and it gives me a lot of peace of mind. I can see why some people don’t want life insurance but it’s really important to me and my family.