How Much Life Insurance Makes Sense

There is no right answer that applies to everyone. The issue is around insurance poverty. Paying for life insurance you don’t need affects today. Paying too little affects those who will survive.

The process is fairly straightforward.

Think about it as converting all the take-home pay cheques you were expecting into a lump sum of cash. Like buying out the contract of a basketball player.

Make it as simple as possible. You do that by thinking about the need in terms of time. For someone young, it looks like this.

Erase the past. Payoff mortgages, car loans, student loans, credit cards, and whatever else there may owe.

Address the present. Estate costs, funeral, medical bills, money to allow time off from work for the survivor, travel costs possibly.

Provide for the future. The most complex of all, but not impossible.

What do you think your family will need to get along with no additional changes to their lives. If the mortgage and other loans are gone, that reduces monthly cost of living. Take that into account. Sometimes people are in a rental situation. Consider capital to buy a home. Think about any other lumpy things you intended to buy and finance.

Provide for future cost of living. There are several considerations:

  • How much cash comes into the family budget from working. Much of it will be replaced by having no debt payments. What’s left? Take home pay minus debt payments. Maybe nothing, but unlikely.
  • Then the fine details.

Delete costs in your current cost of living directly related to the person who died. The golf club fees, the costs to commute, clothing, second car, some food, and more. Then add costs you will incur because the person is no longer there. House repairs, baby sitting, maybe daycare, Purchased meals because less time to prepare them. There is a long list but most are small enough that it doesn’t matter. Best guess

Then deduct after-tax spontaneous income. Things like amounts from a government plan. Sometimes an employer pension plan will pay monthly. Most will settle up with a lump sum.

What’s left is the monthly cash the family was expecting to live in their same world.

How long do you want it. The need will change as children grow older and eventually go off on their own. Consider inflation and the after tax-income the money can earn.

The answer is usually a surprisingly large number. For example for $1,000 a month to spend for 30 years with 3.5% income, a 30% tax rate, and 2% inflation requires a lump some of $338,000. Consider the investment rate. You might want to avoid volatile investments. Notice the tax rate is marginal rate not average rate.

Provide for education. Not such a hard thing. Notice inflation. College costs have been going up much more quickly than the CPI. Notice after tax investment income. In Canada use a RESP

Add all the pieces and deduct spontaneous capital. Group life insurance, existing savings, sell the bass boat. Notice any other life insurance you want to keep, larger amounts often have lower price per thousand of coverage so you may want to replace it.

Finally arrange coverage for what remains. 

There are choices. Most young people choose term insurance because the price is low and provides them with some option. The need will be greatest now. Many choose 20-year renewable term. The coverage will provide a fixed price for twenty years and that gets the kids looked after, if nothing happens. It is not particularly expensive.

For a male non-smoker age 30, in standard health and no exciting pastimes $1,000,000 of coverage would be about $55.00 a month. You can likely find it cheaper but with carriers who may not have useful options like conversion. Be sure there is no pre-existing condition clause. If there is it will be cheap, but they might not pay.

For a female the same coverage is in the $40 a month range.

The takeaway

Life insurance is a supremely rational decision. It may require some arithmetic. The present value of a future monthly needed amount. You probably should assess the investment income expectation carefully.

You should consider how stable the survivor’s income is. The job loss could be catastrophic. Provide a cushion.

Just do it and every year or two rethink it. Maybe your spending and debt have gone way up.

Like many problems, solved right once, solved for a long time. Another of the reasons to choose a large insurer.

As you grow older, other calculations apply. If you own a business, they apply now.

Pay attention to reason. $1,000,000 doesn’t go as far as you think.


I help people have more retirement income and larger, more liquid estates.

Call in Canada 705-927-4770, or email don@moneyfyi.com

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