Life insurance

[kimmarg]

My spouse and I are purchasing life insurance for the first time. We are pretty much the classic case for life insurance, mid-30s couple, healthy with 1 child and mortgage and student loan debt. A friend of ours in a similar demographic recently got diagnosed with a terminal illness and made us realize how important it was to get life insurance now. The goal of life insurance would be to insure that the surviving spouse (or child's guardian) would have enough money to pay off our debts and live at our current standard for several years while adjusting to the new normal. We are looking at 25 year term policies for $500,000. This would pay off house + student loans + 10 years expenses at current rate, or house + student loans + 5 years expenses + surviving spouse back to school or house + student loans+ 5 years expenses + college for child, etc.  Is this a reasonable amount? High? Low? anything else we should consider?

[terran]

Perfectly reasonable.

Given how cheap term insurance (what you should be getting) is, I would take a look at what it would cost to make the surviving spouse "financially independent" of the other spouse's income -- meaning an amount that would make it so the surviving spouse could continue in an acceptable lifestyle forever assuming they continue at their current income, while still saving such that they could retire and also drop their own income at an acceptable age. I think you could approximate this in a back of the napkin way by finding the ratio of each spouse's income to total household income, multiply that by total household spending, and divide by an acceptable "forever" safe withdrawal rate. So if you make $25k, you wife makes $75k and you spend $40k then you should have 0.25*40000/0.035 = $285k policy and your wife should have a 0.75*40000/0.035 = $847k policy. Of course round up to a more even number. Adjust for your actual numbers.

You might decide you want to stick with your plan of requiring that the surviving spouse make some changes to increase income, but I suspect you may find that a term policy is cheap enough that you'll just decide to insure away this necessity.

As far as how long a term to get, I would go a bit longer than you expect it to take to be FI on your savings. 20 years was plenty for us when we were 30 because we expect to be minimally FI by 40 and certainly there by 45.

Another thing to consider is what each of your social security death benefits will be. If you have enough credits the surviving spouse will get a SS payment until your youngest child is 18 years old.

[AMandM]

The amount and term both seem reasonable to me, very similar to what we have.  Someone told us that you need enough to make the surviving spouse totally FI, but we figured that was overkill.  For one thing, we'd be building up savings during the term of the insurance, so the life insurance benefit wouldn't be all there was to live on (unless you die very soon after taking out the policy).  Plus, whichever of us survived would not mind earning some money if necessary.
If, God forbid, we both die simultaneously, the double benefit would be enough to make the kids' guardian FI.

[Illgetthere]

I would take the student loans out of the equation unless they are private and you have a co-signer

[seattlecyclone]

The amount of insurance you need really depends on your priorities. On one end of the spectrum you might decide that your spouse earns enough on their own to do fine if you were to die suddenly, and therefore buy no insurance. On the other end of the spectrum you might decide that life insurance is pretty cheap so you might as well buy enough that your surviving spouse would be FI and your kid would have college paid for if you died tomorrow. You might fall somewhere in between. There's no one-size-fits-all answer here. Pick something that works for you.

Be aware that the amount of insurance you need will decrease as you approach FI. Also be aware that social security can provide some pretty decent benefits for surviving spouses who are still raising kids. You can look up how much you might qualify for online. Take this into account when deciding how much insurance and what sort of term makes sense.

[boarder42]

You should also consider IF you even need insurance at all.   Depending on the size of your stash and something too many people here over look(i know i did until i was informed)

SSA survivor benefits - your husband you can both go make accounts at SSA.gov - this will show you what your spouse and child will receive if you were to die today.  in our case its close to 50k a year with one kid and 60k per year with two kids until the first child turns 16 then its back to 50k and drops to 24k when the second child turns 16 - and completely goes away at 18

I'd start with that then determine what if any insurance you need.

[calimom]

In your life situation, a $500,000 policy sounds about right. Given the fact you have student loan debt and a mortgage, it's safe to assume you're in the building stage of life and don't have tons of cash laying around. I'm guessing the premium quote you've received is pretty reasonable?

I was widowed at 31 with 3 kids, and in retrospect (hindsight and all that) felt we were fairly underinsured for the size of our family and the fact that I had stopped working the year before after the birth of our last child. We thought, if we'd thought about it much at all, that whatever insurance through my husband's well paying job was plenty, and I'd like to think we were not complete financial idiots. Who dies in their 30s anyhow? It does hit home when you know someone close to you going through an illness. Sorry to hear about your friend. In my family's circumstance it was a car accident. I did later receive an additional payout through our auto insurance for the UIM motorist claim, which helped.

Social Security is certainly part of the puzzle - I am forever grateful. But even with COLAs it does freeze at the date of death of the insured. So, what seemed pretty reasonable in 2007 is not as great in 2017. We took the Family Max for only the 3 kids, as I knew I'd be working. The surviving spouse can claim, but only if they earn under $16,000 per year, then it dissipates. It does end at the final child's age of 18 (or 19 if still in school) just as college expenses start. This used to go through 22 if in school, but that program went away years ago. To me, this is where the value of life insurance benefits is really valuable. My eldest had a scholarship to an art school, which was great, but for my younger two knowing that there was a stash for higher education would be such a relief. I'm scrambling to fund 529s. If any $$ is saved from the SS benefits, it must be reported to SSA and turned over to the child upon reaching 18 - so I save out of "my" own funds.

Another thought, kinmarg, is that your and your spouse's student loans might discharge upon death. Sometimes yes, sometimes no. However you proceed, wishing you well, and hope this is something that's never needed in any case. I know we all optimize and are spending averse here but life insurance is something you invest in and hope you never need. It really goes against a lot of the things discussed on this forum.

[thingamabobs]

Are your student loans federal or private? I thought fed loans are discharged if the borrower dies.

[Goldielocks]

My formula..

A) Calculate Need
For each person, calculate what they need if the other dies:

LOANS: Surviving spouse student loans + other household credit debts
PLUS+ 10 years of EXPENSES including mortgage payments
 PLUS+ 10 years extra CHILD CARE /home assistance for single parent
PLUS+ Minimum additional EDUCATION FUNDS for children or spouse to go back to school

MINUS 9 years of surviving parent's INCOME, after taxes
MINUS 40% of your joint RETIREMENT STASH TODAY... because only half of you will be retiring so you need less

EQUALS TERM INSURANCE COVERAGE needed, with some extra in the first year


Notes
 I use 9 years of income only, because there can be some other time of death costs, time off work, etc., and I do not inflate the surviving spouse salary even if they are less than 10 years in their field, because single parents can be challenged to grow income as lots of overtime is hard to do when you have kids as a single.

This formula gives the surviving spouse 10 years to figure it out, with a clean start with no loans and no more saving for kid education needed..   It does not pay off the mortgage, however, because before 10 years are done, they will likely move.

B) Repeat for second spouse.   
 
Some couples will need 2x the insurance on one spouse versus the other.

C)  Buy term insurance through when the kids will be at least 15 years old.. (you should not need as much life insurance after that)

D)  Recheck your need every 5 to 10 years.
Incomes change over time, as do housing expenses, medical coverage, size of your retirement funds, etc. 

The goal is to become self-funded for your life insurance needs after the kids are out of high school and before term life insurance rates spike.



ETA:  Reformatted

[kimmarg]

Thank you for the feedback everyone.  I hadn't considered Social Security. With that factored in $500k is likely enough for FIRE. It's true we'll probably need less as time goes on but with a quote for $335/year and $400/year for each of us I'm not overly concerned about being slightly overinsured.

You're right, they are federal student loans and thus would go away if the person with the loans dies. However as it happens one of us has student loans ($50k) and one of us has a position that would require a significant increase in childcare without the other (works nights would need overnight care to replace spouse) so it seems like either way having that $50k built in isn't a big concern.

Our stash is pretty small at this point, with a net worth near zero (I think I could cash in the retirement account and just barely pay off the house after taxes, not that that would be a smart idea). I'm assuming many people on this board can self insure but a zero net worth family with small kid feels like the poster child for life insurance.

calimom I'm so glad it worked out for you, certainly its a situation noone wants to face but planning for it is all we can do.

[seattlecyclone]

Have you considered disability insurance? I think it's probably more important than life insurance. If you die, you at least stop needing food, shelter, and medical care. Not so if you become disabled. Your expenses might even go up because you might need to hire help for certain basic tasks.

[Goldielocks]

Have you considered disability insurance? I think it's probably more important than life insurance. If you die, you at least stop needing food, shelter, and medical care. Not so if you become disabled. Your expenses might even go up because you might need to hire help for certain basic tasks.

+1 for disability insurance being the most important (and very expensive) insurance needed, after health insurance.

You are relying on your ability to earn future income, to sustain your family, yet having an issue that greatly reduces your income is much more likely than death.   If you have two full time incomes, you can rely on each other, but as soon as one partner starts to earn  lower "secondary income", this risk grows.

Also -- Your rates seem pretty expensive to me, assuming that you are not over 40 years old, non-smoker.    Either you are over insuring, have a risky lifestyle or health condition (firefighter? Forester? Fisherman?) or have not shopped around for your term rates.

I am attaching the rate chart for the term insurance I buy (the price goes up every 5 years, we buy one year at a time, with no medical documentation required for same amount renewal).   $400 for a 37 yr old male non-smoker per year would get you $550k...  a 33 year old would get $730k of life insurance, etc.  A 37 y.o woman would get $600k of life insurance for $335/year.  Does that fit with what you are paying?

[kimmarg]

Have you considered disability insurance? I think it's probably more important than life insurance. If you die, you at least stop needing food, shelter, and medical care. Not so if you become disabled. Your expenses might even go up because you might need to hire help for certain basic tasks.

I work for the US Federal government. I was under the impression I was not eligible for disability insurance although I was never clear why. I guess I should look into it.