Owning the right amount of life insurance is important to protect your family. The global pandemic has reminded us time and time again about our mortality and the importance of getting enough 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 in this incredible 10+-year bull market through aggressive savings, retirement company matches, a diversified investment portfolio, rental property cash-flow, and more.
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, but it's still not a bad idea. If you die with a million bucks in debt, you're living large!
As a father of two young children, I often think about the right amount of life insurance to protect my family. Let's go through an example to see what is the right amount of life insurance to protect different types of families.
The Right Amount Of Life Insurance Examples
To demonstrate the right amount of life insurance, let's look at this family of four in San Francisco with two children ages 8 & 7.
- Wife (35 years old) 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. What is the right amount of life insurance for Mr. Robinson? What about for Mrs. Robinson?
Mrs. Robinson's Financial 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 Financial 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 To Protect Your Family
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.
In my opinion, getting a term life insurance policy is the best way to go. It's cheaper and does its job. Although, it's a good idea to familiarize yourself with all the various life insurance options out there.
In retrospect, I should have taken out a variable universal life insurance policy in order to take advantage of the bull market from 2009 – 2020. The cash value in the policy would have grown tremendously!
Right Amount Of Life Insurance Recap
The right amount of life insurance can be obtained by following these key points:
- 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.
- The death benefit is tax free if your estate is below the estate tax threshold ($12.06 million per person in 2012). Hence, getting life insurance is kind of like getting it for free if you pay a high marginal income tax rate.
Life Insurance Recommendation
Check out PolicyGenius, an independent insurance broker that is revolutionizing the way we shop for life insurance – for free! Answer a few simple questions on PolicyGenius’s website and instantly receive free, personalized and comprehensive life insurance quotes.
PolicyGenius provides free, unbiased advice on more than 25 A-rated top life insurance companies they have thoroughly researched and vetted. Because life insurance prices are regulated, you don't have to worry about not getting the best deals. PolicyGenius helps you compare the best quotes all in one place.
My wife was able to double amount of life insurance and pay 20% less thanks to PolicyGenius. It is important to shop around for life insurance because pricing is so opaque.
The right amount of life insurance gives you peace of mind in case you pass. Ideally, you want to cover all your debt and all living expenses until your dependents are financially independent.
The pandemic helped make us realize what the right amount of life insurance per parent was. I am thrilled both my wife and I have matching life insurance policies for the next 20 years. By then, our mortgages will be paid off and our children should hopefully be independent!