How Much Life Insurance Do I Really Need?

Life can be unpredictable, sometimes in the worst possible way. Any of us who are married or especially if we have children have thought about what would happen to our families if we didn’t make it home tonight. As someone who has paid multiple death claims to surviving spouses, I can tell you that no one is ever ready for the heartbreak  that comes with losing a loved one unexpectedly. However, I can also assure you that the financial security that comes with having adequate life insurance means the world to a surviving spouse who has to pick up all the pieces. Not having one’s family have to worry about money at a time when one’s world has been turned upside down is the whole purpose of buying life insurance protection.

Many people don’t even like to talk about life insurance. And it’s no surprise as to talk about life insurance is to talk about our own death - and none of us like to think about that. I’ve literally run across people who refuse to buy life insurance - almost as if it's a bad omen. However I think when we stop to think about it, we all know it’s the right thing to do if we have others depending on us.

On top of the emotional heartache of children losing a parent or spouses losing their life partner, most families would suffer financial devastation without adequate life insurance protection. Despite this fact, the majority of people I speak with when building their financial plans don’t have nearly enough coverage. Oftentimes the only life insurance they have is from a policy at work. When we start talking about this important aspect of their financial plan, most will admit to having thought about purchasing policies but often state that they didn’t know what type of coverage they should buy or how much they should get. Thankfully, figuring this out is pretty simple.

Let’s start with the question about what type of policy one should get. While there is no cookie-cutter answer that fits every situation, for the overwhelming majority of people in the middle market, the answer is LEVEL TERM INSURANCE. Term insurance is by far the most affordable answer when it comes to buying life insurance, meaning that it allows one to get the most coverage for the lowest overall cost. Term insurance is much more affordable because the policy is only covering you for a specified period of time - typically between 10-30 years. As such, a large amount of people buying term policies (as much as 96%) outlive the term. This means that insurance companies can keep costs down on these policy types as there’s a very high likelihood that a claim on the policy will never be made.

Now I hear what you’re thinking - “well why should I pay for something that I most likely will never use?” The answer to that question is the same reason why we buy auto insurance, or homeowners insurance, or health insurance - because we never know who’s going to experience the loss. Plus, because term insurance is so much less expensive (typically 5-8 times less) than its permanent insurance counterparts, one can “buy term insurance and invest the difference.” Following this idea allows one to maximize their life insurance coverage while also historically averaging higher rates of return on the money they invest in their investment accounts.

Let’s look at an idea known as the theory of decreasing responsibility. As seen below, when one is younger, this is really when they need life insurance coverage. Why? Well, it’s because a younger family typically has kids, debt, a mortgage, and they don’t typically have a lot of money saved yet. As such, if a husband or wife dies earlier in their lives, that loss of income is financially devastating to their family. However, if we fast forward to when people are nearing retirement, let’s say in their early 60s, at that time their kids are grown, their debt is gone and their mortgage is paid off. Plus, if they’ve been investing over the course of their lives, they have a ton of cash built up in their retirement accounts. So if a spouse were to die at this stage of life, it’s still sad emotionally however it’s not financially devastating.

So how does one figure out how much life insurance coverage they need? Thankfully, it’s a pretty simple process. Here are a few simple questions one can answer to determine their total life insurance needs.

1. If your spouse died, how much money would you need per month to maintain your family’s current lifestyle?

For those who are the primary earners, consider if you’d be able to maintain your current work schedule without your spouse to help with the kids. Remember, if a stay at home spouse is the one who dies, it’s not just a husband or a wife who has lost a spouse, it’s also children who have lost a mother or a father. Typically, the surviving spouse will not be working nearly as much for the first year or so to help maintain the home front and be there for grieving kids.

2. What is your mortgage balance and monthly payment?

3. What is the total amount of consumer debt you have (i.e. auto loans, credit cards, personal loans, medical bills, student loans) and what are the monthly payments?

4. How long would you need this monthly income for (typically, income is needed until kids are out of the house)?

5. What are your Social Security survivor benefits?

Many people forget to factor in social security benefits into their calculation. These can be found creating an SSA.Gov login.

Let’s use a hypothetical situation to demonstrate how these questions work to answer the question of how much coverage one needs. Let’s assume an individual answers the previous questions as such:

Q: If your spouse died, how much money would you need per month to maintain your family’s current lifestyle?

  A: $6,000 per month

Q: What is your mortgage balance and monthly payment?

  A: $300k and $2000 per month

Q: What is the total amount of consumer debt you have and what are the monthly payments?

  A: $40,000 and $1,200 per month

Q: How long would you need this monthly income for?

  A: 15 years

Q: What are your social security survivor benefits?

  A: $2,200 per month

How does this all come together? Well, if we start with $340k of coverage, that would eliminate the mortgage payment as well as all the consumer debt. It would also free up $3,200 per month in needed income by paying these debts off. Thus, if we start with the $6,000 per month needed and then subtract the $3,200 that’s been freed up by paying off the debt, we’re left with a monthly need of $2,800. If social security survivor benefits are going to cover $2,200 per month of that, then really there is only a need of $600 additional on a monthly basis.

Let’s say we want to provide that $600 monthly for the next 15 years. That’s only $108,000 needed to do that. However, if we use a 3% inflation rate over that same period of time, we come up with a total need just shy of $134,000.

To bring it all together, in this example, we would need a total of $474,000 - $340k to cover debt and $134k to provide replacement monthly income for 15 years. As you can see, it’s pretty simple to figure out when you know what you’re looking for.

Moving on to Social Security survivor benefits - let’s cover how this works. One can check their survivor benefits by creating a SSA.gov login. Once they’ve made an online account, they can easily see their anticipated benefits - both at retirement and their survivor benefits. The way survivor benefits work for younger families is that a surviving spouse and surviving children are eligible to receive a determined benefit up to a household maximum benefit amount. Surviving spouses qualify for the amount as long as they are caring for surviving children under the age of 16. Children, under the age of 18 (except for specific circumstances), also are eligible for benefits.

In conclusion, taking a few minutes to determine your family’s needs can make the difference between financial devastation or not during an unexpected loss. If you have others depending on your income, I highly encourage you to review your needs and seek out the proper amount of life insurance. When done right, it’s typically inexpensive. However the small premium paid can deliver in the biggest possible way if tragedy were to strike your family. And I promise you, your spouse and kids will forever be grateful for you taking the time to ensure their financial security even if you’re not around to personally provide it.

Have more questions or want to see what coverage would cost for you? Email us at Questions@LetsWinWithMoney.com