Author Topic: Shouldn't Life Insurance Cover Expenses, Not Income?  (Read 3338 times)

ReadySetMillionaire

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Shouldn't Life Insurance Cover Expenses, Not Income?
« on: March 05, 2018, 07:48:57 AM »
My wife and I are in the market for term life insurance, which has resulted in over-analytical me thinking a ton about how much life insurance each of us need to have. 

Almost everything I read online about this topic indicates that you should insure based on anticipated lost income. One of my good friends, who I consider to be very intelligent, used to sell insurance and was telling me that he's insured for $3M.  But this general principle and my friend's insurance amount don't really make sense to me.

I'm stating the obvious for regulars here, but I think one of the core revelations of this website is that your retirement number is based on expenses, not income.  This dramatically changes calculations, planning, and outlook.

I think this principle applies with equal force to life insurance--you should get enough life insurance to cover expenses, not income.  My calculation is as follows:

$10,000 -- burial expenses
$110,000 -- pay off mortgage
$300,000 -- ten years of living expenses (adjusted for inflation)
$120,000 -- public college tuition for two kids
$60,000 -- money to invest in an IRA for ten years (adjusted for inflation)
------------------------
TOTAL = $600,000 policy

My thought is that we already have a decent amount of retirement assets, and covering the living expenses for ten years will allow either spouse to continue to invest for ten years, which would lead to FI.

Am I oversimplifying this, or is this the frugal way to look at term life insurance?



ketchup

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Re: Shouldn't Life Insurance Cover Expenses, Not Income?
« Reply #1 on: March 05, 2018, 07:54:30 AM »
That seems solid to me.  Paying off the mortgage doesn't seem like it has to be a line item in there, but that's up to you.

ReadySetMillionaire

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Re: Shouldn't Life Insurance Cover Expenses, Not Income?
« Reply #2 on: March 05, 2018, 09:15:27 AM »
That seems solid to me.  Paying off the mortgage doesn't seem like it has to be a line item in there, but that's up to you.

The "expenses" itemization anticipates not having a mortgage payment, so I could just lump it down there.  Thanks.

Dee18

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Re: Shouldn't Life Insurance Cover Expenses, Not Income?
« Reply #3 on: March 05, 2018, 09:21:05 AM »
You might want to factor in benefits your children and wife would be entitled to from Social Security.

Paul der Krake

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Re: Shouldn't Life Insurance Cover Expenses, Not Income?
« Reply #4 on: March 05, 2018, 09:21:40 AM »
Don't forget to count Social Security Survivor benefits, which amounts to real money while your kids are minors.

But yes, you've got this right, with the caveat that the expenses need to reflect the additional cost incurred by losing the free labor of one parent.

ReadySetMillionaire

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Re: Shouldn't Life Insurance Cover Expenses, Not Income?
« Reply #5 on: March 05, 2018, 09:38:07 AM »
You might want to factor in benefits your children and wife would be entitled to from Social Security.

Don't forget to count Social Security Survivor benefits, which amounts to real money while your kids are minors.

But yes, you've got this right, with the caveat that the expenses need to reflect the additional cost incurred by losing the free labor of one parent.

I'm looking into this and getting quite confused as to when these benefits would kick in.

Would the benefits to my children kick in immediately upon my death? What about the spousal benefits--would they be immediate or would they wait until her retirement age?

Paul der Krake

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Re: Shouldn't Life Insurance Cover Expenses, Not Income?
« Reply #6 on: March 05, 2018, 09:50:51 AM »
The survivor benefits for children and spouse-caring-for-children kicks in immediately. Then there are spousal benefits kicking in at retirement age, that are different from the survivor benefits.

Open an account at SSA.gov and check your earning record and estimated benefits. It's a good idea to do so yearly anyway.

For illustration, here's what my spouse and children would get if I died today:


KMMK

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Re: Shouldn't Life Insurance Cover Expenses, Not Income?
« Reply #7 on: March 05, 2018, 10:02:49 AM »
Insurance broker, here. Yes, you are correct. The income X # method is an old-school way where we talk about brokers selling insurance with a napkin at the kitchen table. Now, proper financial needs analysis is the way to go.

Here is how I do the calculation of need:

Part 1 - monthly/ongoing expenses:
- regular expenses (including mortgage) less the income of survivor (their income/survivor benefits), less expenses that will disappear with one adult gone (2nd car for example) X number of years of support
- amounts for children X number of years of support
- extra expenses that may occur with only 1 parent - daycare/nanny, cleaner, lawncare, etc

Part 2 - one-time expenses
- funeral costs
- total expenses for a year or two - assume the survivor will not want to immediately return to work, or may not be able to (consider a major car accident with both of you)
- kids education funding if desired
- spouse retirement funding if desired
- amount to pay off any debts or for major purchases - car, roof, etc

Add up all these numbers. Then subtract current available money - savings, work life insurance, etc.
That gives you a good total of coverage to get. Of course the amount required will decrease over time, as the kids get older, the mortgage is paid off, and your savings increase.

So often it makes sense to reduce your coverage over time - either by a layered method and/or a decreasing face value policy.

ReadySetMillionaire

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Re: Shouldn't Life Insurance Cover Expenses, Not Income?
« Reply #8 on: March 05, 2018, 10:08:50 AM »
Insurance broker, here. Yes, you are correct. The income X # method is an old-school way where we talk about brokers selling insurance with a napkin at the kitchen table. Now, proper financial needs analysis is the way to go.

Here is how I do the calculation of need:

Part 1 - monthly/ongoing expenses:
- regular expenses (including mortgage) less the income of survivor (their income/survivor benefits), less expenses that will disappear with one adult gone (2nd car for example) X number of years of support
- amounts for children X number of years of support
- extra expenses that may occur with only 1 parent - daycare/nanny, cleaner, lawncare, etc

Part 2 - one-time expenses
- funeral costs
- total expenses for a year or two - assume the survivor will not want to immediately return to work, or may not be able to (consider a major car accident with both of you)
- kids education funding if desired
- spouse retirement funding if desired
- amount to pay off any debts or for major purchases - car, roof, etc

Add up all these numbers. Then subtract current available money - savings, work life insurance, etc.
That gives you a good total of coverage to get. Of course the amount required will decrease over time, as the kids get older, the mortgage is paid off, and your savings increase.

So often it makes sense to reduce your coverage over time - either by a layered method and/or a decreasing face value policy.

Thanks for the information.  This leads me to believe I may be electing too much coverage.  Would you agree?

Also, what term would you recommend?  As the above poster alluded to, we may be self insured within about ten years.  Should the term only be ten years, or do 15  just to be safe?

Imma

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Re: Shouldn't Life Insurance Cover Expenses, Not Income?
« Reply #9 on: March 05, 2018, 10:17:02 AM »
Yes, this is the right way to calculate how much life insurance you need. I think many people are vastly overinsured. It means your relatives will be rich if you happen to die, but the most likely scenario is that you pay a fortune in life insurance and not get anything in return.

We have chosen for a EUR 100.000 life insurance policy. We are covered until I'm 54 / he's 58. We calculated the necessary amount in two ways. The first way: total outstanding mortgage (at that point around 80k, lower now) burial costs after insurance (5k) + inflation = about 100k. Then we looked at our joint bills, took half that amount and multiplied it by 25 = also around 100k. If my partner would pass away, I'd have the option to either pay off the mortgage and have low bills forever or invest the payout and his half of the bills would be covered forever. Of course, we don't have children, so we don't have to factor in the cost of raising children. I can imagine you want to be 100% sure your children are taken care of in case the worst happens.

As for your calculation, are you sure you're not counting your mortgage payments twice?  If the projected living expenses already include the mortgage payment, you could consider lowering the amount to 500k.

KMMK

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Re: Shouldn't Life Insurance Cover Expenses, Not Income?
« Reply #10 on: March 05, 2018, 10:32:01 AM »
Insurance broker, here. Yes, you are correct. The income X # method is an old-school way where we talk about brokers selling insurance with a napkin at the kitchen table. Now, proper financial needs analysis is the way to go.

Here is how I do the calculation of need:

Part 1 - monthly/ongoing expenses:
- regular expenses (including mortgage) less the income of survivor (their income/survivor benefits), less expenses that will disappear with one adult gone (2nd car for example) X number of years of support
- amounts for children X number of years of support
- extra expenses that may occur with only 1 parent - daycare/nanny, cleaner, lawncare, etc

Part 2 - one-time expenses
- funeral costs
- total expenses for a year or two - assume the survivor will not want to immediately return to work, or may not be able to (consider a major car accident with both of you)
- kids education funding if desired
- spouse retirement funding if desired
- amount to pay off any debts or for major purchases - car, roof, etc

Add up all these numbers. Then subtract current available money - savings, work life insurance, etc.
That gives you a good total of coverage to get. Of course the amount required will decrease over time, as the kids get older, the mortgage is paid off, and your savings increase.

So often it makes sense to reduce your coverage over time - either by a layered method and/or a decreasing face value policy.

Thanks for the information.  This leads me to believe I may be electing too much coverage.  Would you agree?

Also, what term would you recommend?  As the above poster alluded to, we may be self insured within about ten years.  Should the term only be ten years, or do 15  just to be safe?

I don't have enough information to determine how much coverage and I can't give specific advice anyhow due to licensing restrictions.

As far as term, yes, I'd take longer than 10 - just in case your life changes. You can always cancel it mid-term as well. You may also buy a term 10 and a term 20. So you have more coverage for the next 10 years, then less the 10 years after that.

ReadySetMillionaire

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Re: Shouldn't Life Insurance Cover Expenses, Not Income?
« Reply #11 on: March 05, 2018, 12:27:42 PM »
As for your calculation, are you sure you're not counting your mortgage payments twice?  If the projected living expenses already include the mortgage payment, you could consider lowering the amount to 500k.

Not counting twice.  Projected living expenses assume that the mortgage is paid off.

More importantly, thanks for your calculation example.

katsiki

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Re: Shouldn't Life Insurance Cover Expenses, Not Income?
« Reply #12 on: March 05, 2018, 12:32:36 PM »
As far as term, yes, I'd take longer than 10 - just in case your life changes. You can always cancel it mid-term as well. You may also buy a term 10 and a term 20. So you have more coverage for the next 10 years, then less the 10 years after that.

I was going to post about this...  I believe it is called laddering (like a CD ladder).

@KMMK, would you recommend getting both policies with the same company?

KMMK

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Re: Shouldn't Life Insurance Cover Expenses, Not Income?
« Reply #13 on: March 05, 2018, 12:56:56 PM »
As far as term, yes, I'd take longer than 10 - just in case your life changes. You can always cancel it mid-term as well. You may also buy a term 10 and a term 20. So you have more coverage for the next 10 years, then less the 10 years after that.

I was going to post about this...  I believe it is called laddering (like a CD ladder).

@KMMK, would you recommend getting both policies with the same company?

Usually that's the easiest way. At least in Canada the insurance companies are so heavily regulated, and have back-up coverage in case of insolvency, so I'd be comfortable having it all with one company. Also sometimes there's an annual policy fee, which might be duplicated if you have 2 providers.

BTDretire

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Re: Shouldn't Life Insurance Cover Expenses, Not Income?
« Reply #14 on: March 05, 2018, 02:22:15 PM »
The survivor benefits for children and spouse-caring-for-children kicks in immediately. Then there are spousal benefits kicking in at retirement age, that are different from the survivor benefits.

Open an account at SSA.gov and check your earning record and estimated benefits. It's a good idea to do so yearly anyway.

For illustration, here's what my spouse and children would get if I died today:



Paul your way up there!
My child would get $1,419 and my wife $1,419.

calimom

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Re: Shouldn't Life Insurance Cover Expenses, Not Income?
« Reply #15 on: March 05, 2018, 05:56:18 PM »
The survivor benefits for children and spouse-caring-for-children kicks in immediately. Then there are spousal benefits kicking in at retirement age, that are different from the survivor benefits.

Open an account at SSA.gov and check your earning record and estimated benefits. It's a good idea to do so yearly anyway.

For illustration, here's what my spouse and children would get if I died today:



That's a pretty generous SS award! I was widowed in 2007 at age 31 with 3 children and don't receive anywhere near that amount in Survivors' Benefits. Also remember the caregiver parent can only collect until the youngest child is 16, and the children age out at 18 (or 19 if still in high school). So no benefits during college and a non working surviving parent may find themselves in a financial bind. My husband was 37 and a good earner, but the account really builds the more you make and the older you get. Trust me, I'm not complaining about these benefits or this program - we've received far more than my husband ever put in during his working years. I've never collected as the caregiver spouse because we got the Family Max at first and when I returned to work, I knew I'd be making  over the cutoff of $16K per year.

For life insurance itself, take all the factors into consideration: size or projected size of family; whether there may be a non earning spouse; overhead; and thoughts on higher education for your dependents. For many families, a $500K policy is likely sufficient, coupled with low to no debt, some savings and other assets, and the ability of the surviving parent to support themselves and prepare for their own retirement. But the early death of one parent can create some additional and unknown expenses, such as the possibility that the death could have been preceded by a long, costly illness. Also the surviving parent my have to outsource childcare and household help and repair that previously was not needed.

My late husband was somewhat underinsured for the size of our family and ages of our children - he had the equivalent of a year's salary and we had a smaller policy. But there was a payout from our auto insurance (he was killed by an uninsured drunk driver) which created a better safety net.

Kudos to you, OP, for thinking about this and optimizing the best coverage. It's hard to pay for something you hope you will never need.

chasesfish

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Re: Shouldn't Life Insurance Cover Expenses, Not Income?
« Reply #16 on: March 05, 2018, 06:58:19 PM »
Your spot on with your analysis.  We dropped our additional term life insurance a couple years back when we hit our Lean FI number.  I knew I wasn't changing companies prior to retirement, so the little I have left if just a company benefit.

Paul der Krake

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Re: Shouldn't Life Insurance Cover Expenses, Not Income?
« Reply #17 on: March 05, 2018, 09:07:01 PM »
That's a pretty generous SS award! I was widowed in 2007 at age 31 with 3 children and don't receive anywhere near that amount in Survivors' Benefits. Also remember the caregiver parent can only collect until the youngest child is 16, and the children age out at 18 (or 19 if still in high school). So no benefits during college and a non working surviving parent may find themselves in a financial bind. My husband was 37 and a good earner, but the account really builds the more you make and the older you get. Trust me, I'm not complaining about these benefits or this program - we've received far more than my husband ever put in during his working years. I've never collected as the caregiver spouse because we got the Family Max at first and when I returned to work, I knew I'd be making  over the cutoff of $16K per year.
I couldn't find the exact formula used for survivor benefits, but it's definitely based on one's individual record. If my wife, who has always earned significantly less, dies, it will not be as cushy.

I'm both saddened that you lost your husband so young, and happy that the program was there for you. It's a fantastic safety net that gets little press because insurance agents don't earn a living emphasizing government programs and downsizing private insurance needs.

(one major criticism is that it doesn't work for minorities, who have children out of wedlock and die from crime at much higher rates than whites)

As lhamo said, Mustachians have reduced insurance needs. We've always declined to purchase.

Laura33

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Re: Shouldn't Life Insurance Cover Expenses, Not Income?
« Reply #18 on: March 06, 2018, 07:03:12 AM »
Don't forget to count Social Security Survivor benefits, which amounts to real money while your kids are minors.

But yes, you've got this right, with the caveat that the expenses need to reflect the additional cost incurred by losing the free labor of one parent.

This. 

The other thing is that you don't have kids yet, right?  You might want to consider "overinsuring" (as compared to what you need now), because if you decide you need more after you have kids, and you have developed some sort of condition in the interim, you may not be able to get more insurance, or you may have to pay a ridiculous rate.

For us -- 2 full-time working adults, 2 kids -- we erred on the higher side by MMM standards.  We could have gone with nothing to very little -- with two full-time jobs, and expenses that we could cover on one income, we'd have been ok with nothing.  But I also knew that I wanted flexibility in the event that DH died young -- maybe I'd want to take a year or two off work to help the kids adjust; maybe I'd want to kick back to half-time until they were out of the house; maybe I'd want a live-in nanny/housekeeper so I could keep my job as is; etc. etc. etc.  Plus I knew I wouldn't want to have to worry about college.  And finally, I also knew that inflation would eat away at the face value of the policy over the next 20 years.  So we ended up going with $1M -- I'll be honest, I didn't do specific math, just basically assumed @$50K/yr for maybe 10 years for a nanny + about another $500K for college/inflation/mortgage payoff/etc.  High by this site's standards, but massively low for what people were telling us we needed.

Speaking of which, it's time to go back and take another look at that -- now that we're over 50, the rates have increased dramatically, we are past the daycare stage, and we have college and retirement pretty much covered.  Glad we didn't need it!  But will also be glad to stop throwing money at it.

jax8

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Re: Shouldn't Life Insurance Cover Expenses, Not Income?
« Reply #19 on: March 07, 2018, 07:47:19 AM »
The survivor benefits for children and spouse-caring-for-children kicks in immediately. Then there are spousal benefits kicking in at retirement age, that are different from the survivor benefits.

Open an account at SSA.gov and check your earning record and estimated benefits. It's a good idea to do so yearly anyway.

For illustration, here's what my spouse and children would get if I died today:



Thank you so much for this!  I found this whole thread incredibly helpful, but I had no idea that social security survivor benefits exist.  Checking this really put me at ease!

I have a $250,000 term policy that I bought at age 30.  I was only employed part-time while taking care of our kids and wanted something to help my husband pay for daycare if something ever happened to me--and $60 every quarter was all I really wanted to spend on it. 

My husband only has $150,000 policy through his work.  He's 46 and had three hospital stays and two emergency surgeries (gall bladder and an intestinal tear) so buying anything now would mean high premiums.  I've been assuming that if he died, the kids and I would only have $150,000 and the "gift" of his student loans being forgiven.  I had no idea that social security survivor benefits existed!  His estimated monthly payouts are enough to equal his lost take home pay.  That's incredible!

I freaking love this site.  I learn something new (and so incredibly helpful!) every time I come here.

myrrh

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Re: Shouldn't Life Insurance Cover Expenses, Not Income?
« Reply #20 on: March 07, 2018, 09:00:47 AM »
Paul, please rethink your assumption that all minorities live in crime ridden neighborhoods and have children out of wedlock. I will think about my assumption of the same about low income people. Thank you.

Regarding social security survivor benefits, assuming both DH and I die, would my kid's benefits be paid to my parents (my kid's guardians)?



Paul der Krake

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Re: Shouldn't Life Insurance Cover Expenses, Not Income?
« Reply #21 on: March 07, 2018, 09:22:15 AM »
Paul, please rethink your assumption that all minorities live in crime ridden neighborhoods and have children out of wedlock. I will think about my assumption of the same about low income people. Thank you.
I didn't write "all minorities live in crime ridden neighborhoods and have children out of wedlock". I wrote "minorities, who have children out of wedlock and die from crime at much higher rates than whites".

This is relevant information when discussing a program designed for spouses and their children in the event of early death. Or are you disputing these verifiable claims?

Regarding social security survivor benefits, assuming both DH and I die, would my kid's benefits be paid to my parents (my kid's guardians)?
Yes, the kids' benefits are usually paid to the guardian, because it's a bad idea to give minors money directly.

calimom

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Re: Shouldn't Life Insurance Cover Expenses, Not Income?
« Reply #22 on: March 07, 2018, 10:41:46 AM »


Regarding social security survivor benefits, assuming both DH and I die, would my kid's benefits be paid to my parents (my kid's guardians)?

In the (unthinkable but possible) event that both parents die, the survivors will receive benefits from only one earner - likely the highest one of course.

myrrh

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Re: Shouldn't Life Insurance Cover Expenses, Not Income?
« Reply #23 on: March 07, 2018, 11:16:47 AM »
ok thanks Paul and Calimom. Paul, I'm not arguing that social security provides death benefits. I am just questioning why you feel bringing race into the conversation was needed. I really don't feel it is.

Michael in ABQ

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Re: Shouldn't Life Insurance Cover Expenses, Not Income?
« Reply #24 on: March 09, 2018, 04:56:12 PM »
I bought a $500,000 20-year level term policy for about $250/year (male, 32 at the time, very healthy). The price difference between $500,000 or $750,000 or a million is not going to be a large amount. I also have another $400,000 through the National Guard ($336 a year but I get a refund for the premiums each year) and then another $100,000 or so from my regular employer.

A quick calculation is 10-12 annual income which for most people will be somewhere between $500,000 and a million. With SS benefits unless you have a very large mortgage or some other unusual expenses $500,000 will probably cover the majority of people just fine. We have 5 relatively young kids so for $250 a year it's worth it to get an extra half million in coverage that will make the difference between my wife getting by ok and her not having to worry about money, paying for college, retirement, etc. since she's a stay at home mom and will be for at least the next 15-20 years.