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Life Insurance Basics

Before getting to the most important question on life insurance (regarding how much one needs), let’s first get one thing out of the way: For many people, term life insurance is the most efficient option. We strongly believe your “insurance” should merely be insurance and your “investments” should merely be investments – there is no reason combine the two. When combined, the fees increase and the investment options decrease. Both of those factors are to the detriment of the insured. These facts have been discussed at length in the financial planning world (if you’d like the details, please ask, we’re happy to provide them).

So now let’s look at term insurance and answer two relevant questions: (1) how much do I need and (2) how long do I need it? There are several well-known ways to calculate these numbers, but we think we can simplify and avoid any complicated algorithms. Here are our beliefs/assumptions that are behind this simplification:

  1. Term life insurance is relatively inexpensive, so err on the high side.
  2. Your need for insurance ends at retirement. After all, if you’re able to retire, by definition you are financially independent and your death would not have a drastic financial impact on your family. This does assume your home is paid for (or could be paid off with assets), the kids are out of college (and you’re done paying for it), etc.

How much do I need?

Have enough to pay off the house, fund the kids’ education, and then enough left over to provide for living expenses. If possible, provide for living expenses without using principal which would mean you need insurance equal to 25 times your current income. This assumes a 4% withdrawal rate. It is important to consider what life would look like if something were to happen and the policy paid out. The flexibility provided by having living expenses covered without using principal is a significant advantage.

How long do I need coverage for?

As we stated earlier, we only recommend coverage until expected retirement age. There are several common circumstances that can adjust the duration of coverage including the stage of life when applying, health, affordability, and the current financial situation.

When considering purchasing life insurance it is best to consult with a financial planner with a fiduciary duty. This consultation will provide an objective recommendation that takes into consideration all aspects of your financial life. There are situations in which permanent life insurance does make sense and this consultation would determine if yours was such a situation.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Please keep in mind that insurance companies alone determine insurability and some people may be deemed uninsurable.