Life insurance is an important part of any comprehensive financial plan. Unfortunately, figuring out how much and what kind of insurance you need can be confusing.
At its most basic level, life insurance is intended to replace income in the event of death. What needs to be insured are your future earnings when other people count on your income to live. When life insurance is looked at this way, it helps to understand when and if someone needs life insurance.
Because your earning years usually last into your 60s, this is typically the period you need to cover. As your savings and investments increase and your children leave the nest, your need for income protection decreases.
Types of Life Insurance
Term life insurance is purchased to cover a specific term—usually from five to 30 years. Because your earning years are usually from age about 25-65, purchasing low-cost term insurance to cover this period is the most cost-effective way to insure your income.
Whole life insurance, also known as permanent, variable, universal or cash value life insurance is structured to cover your entire life—even after you no longer need it. Whole life usually costs 10-20+ times more than term life insurance so it can be very difficult to get the appropriate amount in a cost-effective way.
There are a few arguments for whole life insurance, but they are mostly for those who will leave large estates (over $13 million for an individual or $26 million for a couple in 2023) or those who own businesses they may want to pass down to kids.
Although only a small percentage of people need whole life insurance, the sales practices for these policies are widely abused. These high commission products are often sold with high-pressure sales tactics and inflated promises. The best advice around purchasing any whole life insurance is to get a second opinion from an advisor who does not sell insurance.
Group life insurance is what your employer provides or what you can purchase through work. This may be the least expensive and easiest to get, but it has a major drawback. If you lose your job, you will lose your insurance. This is why experts recommend purchasing most of your insurance outside of work.
When Do I Need Life Insurance?
The goal should be to purchase multiple term life insurance policies over time as your needs for coverage increase. By staggering the term lengths, the policies will gradually expire later in life as your insurance needs decrease. For example, purchasing 20-year term policies just prior to the birth of each child and then when you move up to a bigger house and mortgage will stagger your policies so that you’re not over-covered or over-paying for unneeded insurance.
Ages and Stages - Just Getting Started
When you’re young and without dependents, you only need enough insurance to make sure you don’t leave any unpaid debt and have enough insurance to cover funeral costs. In this situation, just having coverage through your employer should be sufficient.
There is an argument for purchasing additional life insurance early if you plan to get married and raise a family. There are a few reasons for this: 1) When you’re young, your cost will be low; 2) You never know what kind of health issues may come up in the future. Health issues can make getting life insurance much more expensive; and 3) Good planning means getting insurance in place before you need it, not after the fact. Getting insurance early ensures you don’t have any gaps. Coverage of five times your annual salary would be a good start here.
For example, a 28-year-old who is engaged, plans to have a family, and is making $50,000/year, may want to purchase a $250,000 20- or 30-year term policy.
Before kids start coming, additional term insurance should be in place. Depending on if and how much life insurance you already have, make sure you are covered by at least ten times your annual salary. If you already have a 5x policy for 20 years, this may be a good time to purchase another 5x policy for 30 years. These two policies plus work coverage should be sufficient.
Make sure both spouses have coverage. One spouse may not work outside the home, but the cost of childcare can be expensive.
At this point, your insurance needs will decrease and some of your term policies may have expired. Make sure you still maintain enough insurance to support your spouse and pay off debt. At this stage of life, getting additional insurance can be expensive. Look at coverage through work to round out any shortfalls until retirement.
If you have done proper planning, you should be self-insured going into retirement, which means there is no need for life insurance. If you still have a mortgage, it may be wise to maintain a policy until the mortgage is paid off.
How Much Life Insurance Should I Have?
This obviously depends on a number of factors including your income, spending rate, age, debt, and amount of savings/investments.
Here are simple guidelines that should serve most families well.
Add up all debt and future college costs if you have kids. You’ll want to cover this plus the amount below, depending on your age bracket.
- Ages 25-35: Ten times salary plus at least two times work-provided policy
- Ages 35-45: Eight times salary plus at least two times work-provided policy
- Ages 45-55: Six times salary plus at least two times work-provided policy
- Ages 55-plus: Three times salary plus two times work-provided policy
These numbers are not cumulative by age. Your insurance needs should decrease as you get closer to retirement. If you are close to retirement age but are behind on your retirement savings, you may want to maintain higher levels of insurance.
Where to Purchase Life Insurance
Some of the best places to find inexpensive term life insurance can be online life insurers like SelectQuote, Zander Insurance or Quotacy. You may also have luck with your home and auto insurance company. The important thing is that you stick with term insurance.
As we mentioned before, if an insurance agent pitches expensive whole life or any kind of life insurance as an investment, get a second opinion from someone who does not have a license to sell insurance.
The Bottom Line
Not having enough life insurance could be catastrophic to your loved ones if they count on your income and you die prematurely. Buying whole life/cash value life insurance instead of term insurance could also have a significant negative impact on your lifetime finances.
Having the appropriate type and amount of life insurance can go a long way toward achieving financial peace of mind for you and your loved ones. Hopefully you now have a better idea of the type and amount you should maintain.