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Financial Freedom Is Merely Organized Common Sense
Life Insurance Thinking
In the beginning, life insurance is not as complicated to think about as people believe.
There are three simple questions and one more complicated one that, most young people needn’t care about.
The Questions
Simple enough
- How much should I have?
- How long will I need it?
- How much premium must i commit?
More complicated
- What kind of insurance to buy? More in a minute on that
How much?
Calculating life’s obligations is non-trivial but possible. It is different depending on your circumstances. There is a way to begin thinking about it.
- Clear the present – pay for a funeral, pay for some time off work for the surviving spouse, pay for incidentals like legal and medical costs.
- Clear the past. – pay of all the debts that depended on your income to liquidate.
- Prepare for the future – Your income was to provide opportunities and lifestyle for people who depended on that income. An education fund is one. An emergency fund another. The big one is spendable money to pay for the things they need to live as they wish and you wished. Some of the month to month costs may be paid by government plans. Most of the income will be taxable so watch for that. Don’t forget inflation..
Calculating the future is the only difficult one.
You can start by finding your take home pay for the year and deduct the debt payments that will go away. Your income tax return should give you a clue.
You might subtract expenses like cost of working, and personal expenses. Then add new expenses to be incurred — more childcare, some repairs and maintenance, and more takeout food are common. Some people just ignore both and decide it will work out even. Could be true.
Subtract 2/3 of potential government benefits and of any survivor pensions that might arise. The other third is for taxes.
Estimate the safe income that can be earned on the capital. Over long periods safe income is likely about 1% over inflation after taxes. That is optimistic if inflation is higher than about 3% because taxes apply to the whole thing not just the difference.
Decide how long you need it. There could be steps to it. While children are young, day care is important. As they grow older, that goes away but other expenses appear. When they’re raised, will spouse need some income support?
Calculating the net present value of the spending stream you identified is arithmetically difficult. For an idea. Assume you need $1,000 a month for 20 years and $500 per month for the twenty years after that. Further assume inflation is 2% throughout and the survivor can earn 3% after taxes. That’s about 4.5% pretax. To get an estimate for yourself you could multiply by whatever ratio your spending is to $1,000. It gets harder if you change the time structure. What you might need 5 or 10 years from now might not be so different. The costs may inflate but the time may be shorter. Review once in a while.
For the assumptions about future cash flow needs above, the capital need is $310,000.
So $310,000 plus debt, plus education and emergency funds, plus final expenses.
What is already there?
Could be savings, could be the commuted value of pensions refunded, could be assets you sell, or group life insurance. Don’t forget, the second car, the bass boat, and the golf clubs.
What you need,less what you have is the amount of insurance you need. New money.
How long do you need it?
Most people on their first look at insurance cover to the end of the children being dependent. In this case I used 20 years. Every situation is different. If you have several children, it might scale down as they leave home. That adjustment is possible but the fuiture is not that predictable. So we kept it for 20 years at one number and dropped it by about 55% then to provide spouse with money to save for retirement.
How much premium?
If you cover the right amount, the premium will be some minimum number and there will be many options from there.
Most you people choose, 10-year term renewable. That’s the cheapest. For a male non-smoker in good health, aged 30, $1,000,000 of coverage will have a premium less than $50.00 per month. If you are in great health, have a good family history and no risky hobbies or work, less than $40.
More complicated
You might wish to guarantee the premium for 20 years and avoid the much higher renewal price after 10 years. 20-year term, renewable would have a premium of about $55 per month for normal good health or about $45 for great health.
Participating whole life for a million at age 30, is about $1,200 a month. Using different dividend options, or a non-participating plan, or universal life, you could get almost any number between $100 per month and $1,200.
The reasons you might choose a more highly priced plan is there is a permanent need for coverage, or for building cash values, or for increasing coverage amounts. You could mix and match too. A little permanent and a large term rider for example. It’s about finding your best fit now with flexibility for the future.
For young people, the immediate need is usually quite large and the funds to buy relatively scarce. There is an option you could like some day in the future. Most terms plans are convertible. That means at some point in the future you could change the plan, or part of it, to something with more enduring value. To be sure, use a major carrier. They will likely have something you would like to convert to when the time comes. The cheapest carriers often don’t have participating insurance and some don’t have universal.
It’s complicated. For most people, nearly all, arrange the right amount of coverage with a large company and as your life develops the need for a different product will become more obvious and more affordable.
The Takeaway
Buy what your survivors might need. Insurance poor can relate to the premium you paid or it can relate to the survivors having too little capital to live as you would wish for them.
The arithmetic is a bit scary, but doable. Be in touch if you can’t find how to do it.
Review the plan regularly. Your living components change quickly when you are young.
Pay annually instead of monthly. 12 monthly payments are about 8% more than the annual premium. Easy money if you can make it fit your cash flow budget.
Bank offered mortgage insurance is invariably less valuable coverage and it costs much more. Check.
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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