What Should Life Insurance Cover?

The book The Financial Crossroads lists all the costs life insurance should cover (which helps you determine how much life insurance you need.) Here's their list of the expenses that should be covered by life insurance:

• Final expenses -- costs that one will incur to make viewing, funeral, and burial arrangements.

• Payment of debts and mortgages -- sets the surviving spouse or other heirs free from his or her largest and most demanding bills.

• Education for the children -- For expected costs of private elementary or high school education and especially college.

• Needed income replacement -- Is less than 100% of the spouse's income since our calculations have already pre-paid dents, mortgages, and education. With those major expenses covered, most people will only need to replace approximately 50% of the deceased spouse's income.

They also use 5% as the "safe" return you can expect on your money (though today, 5% is a pretty good rate if you're looking for income-producing assets.) As such, if you need $50,000 a year in income to replace the deceased's salary, you need $1 million ($50,000/.05) in life insurance.

Here's our situation:

• We have enough in our emergency fund to cover the final expenses.

• We have no debt or mortgage.

• Our children's education is about 50% funded or so (will be 100% funded in next few years).

• The difference between what we make and what we spend is rather large, so we don't need to replace anything close to my salary with life insurance. In addition, we have a good amount saved already, so that lessens the need for a ton of insurance anyway. As such, we insure me for about five times my annual salary, which is about 10 times our annual living expenses. We have $350k of life insurance on my wife, the amount I've estimated we'd need to get our kids to graduation without her.

• As I said in How Much Life Insurance Do You Need?, my general formula for how much life insurance anyone needs is this:

Total need - total liquid net worth + a bit of cushion = amount of life insurance needed

I know, it's not very precise -- that's why the "bit of cushion" is in there. ;-)

• We are probably five years away from being self-insured. At that point, we'll still have ten years or so left on our term life insurance policy, so there's plenty of cushion built into our plans.

Comments

[MC]

My kids have another parent with a good job besides me (their Dad; we're divorced), so I figure that having a huge amount of life insurance on myself isn't that important. If I die, he'll mostly be able to finish raising the kids on his own just fine.

I do have some life insurance (a benefit through my employer) and this together with my assets means that if I die my 2 kids will together inherit about $650K (at present; increasing every year). That's plenty to get them through college and maybe give them a down payment on a house each so they can get a good start in life.

I also have a will and an estate plan with trust funds and trustees, so none of the money will be in the control of my ex, and also so the kids won't get total control of it until they're older.

[Budgeting in the Fun Stuff]

We don't have kids and can live on one of our salaries if necessary, so we only have $100,000 life insurance policies right now plus short-term and long-term disability.

That $100k would cover the rest of the mortgage (about $70k), the car (about $9k), the cremation and viewing expenses (about $6k in our area), and leave $15k (6 months of living expenses without a mortgage) to be combined with our emergency fund for whatever time off we'd need to take.

[BenC]

I have $600K term in two separate policies ($500K & $100K) that should take care of the house ($240K) which is our only debt. The rest should be able to put the kids through school college in 15 years and provide very little replacement income for my wife who is a SAHM. So obviously we're looking to increase my insurance. I start a new job in a week that offers 1x my salary at no cost and additional insurance at a cheap price. I'll probably increase it to a total of $750K-$800K at first and then to $1mm if we can afford it later.

[Strick]

Just calculate what you would need to retire today (any college expenses, mortgage payoffs, etc. factored in) and subtract what you have.

Most people don't feel comfortable with 5% withdraw rate at 65 years old, so I definitely don't know why someone much younger would feel that way.

[MasterPo]

Nothing wrong in using life insurance to provide that inheritance nest egg for your kids too.

[Georgai]

I have no debt, own my own home and have a $15k life insurance policy. I told my son and daughter to pay for my burial and I want it like I did for their father. Even if prices go higher, I should have left enough for them. They are to split whatever is left.

Of course, I buried my husband in 2007 for around $4.5k. Not bad, huh? I even buried him in a very beautiful casket. However, said casket was made up of cardboard and cost $850. It takes weight up to 650 lbs. No one knew except those I told (family).

I did this for financial reasons, but also for another reason. I think burial and decay are the best recycling system God ever made. We decay, feed the worms and bugs, and leak chemicals into the soil to help the flowers and grass grow. The worms and bugs feed the birds who also bring beauty into the world. I did not buy a vault or a liner and I have told my children if one is required when I die, they are to cremate me. I do not especially want it, but I refuse to putrify in a vault. I want to add beauty to the world, even after my death.

[getagrip]

In all the life insurance calculations I see no one seems to recall that you're children will get something from Social Security for a deceased parent. Check the statement they send you once a year. If you elminate the debt (e.g. mortgage, car payments), this amount alone may be enough to pay the monthly bills and lower the policy amount needed even if you don't want to believe you'll get the full amount (take some percentage instead then). The only obvious point is that it stops paying once the kids hit 18 and your surviving spouse would need to know that so they can't just sit around but need to get out there and work as well if they aren't working already. The way I figured it, my spouse wouldn't end up having any problems while the kids were at home and could bank most of her salary and leave the insurance money left over (after paying all debts and taking college into account) alone and earning interest until all the kids were grown. So for those years between grown kids and retirement, there would be plenty available unless she blows it all up front on a "thank god he's gone" party :-)

[Denise@AccuQuote]

That’s a nice formula. However, there is the concern that most people won’t be able to work out their life insurance needs as well as you have. When it comes to applying the formula to their lives, it might not be as easy. I highly recommend the use of a good online life insurance needs calculator. By ‘good’ I mean the ones that ask you a lot of details before giving you the figure. There are many life insurance needs calculators available online, and when you calculate with one that asks you a lot of questions, it is likely to be more accurate. The better ones take your investments and inflation into consideration, so they can be pretty accurate.

Denise at AccuQuote
Disclaimer: I work for AccuQuote and this is my personal opinion.