The book Your Money Ratios: 8 Simple Tools for Financial Security lists eight money ratios that are designed to help us all determine where we stand financially. They're so good that the Wall Street Journal called them "some of the best tools we have seen for gauging where you stand." So I thought I'd list each of them as well as tell you where I stand on each measure. This is part four of the series and covers ratios #7 and #8. (FYI, here are #1 and #2, #3 and #4, and #5 and #6).
The Life Insurance Ratio
The life insurance ratio is designed to tell you how much life insurance (relative to income) you should have at various ages. Here's what the author suggests:
- 25 years old -- 12 times income
- 30 years old -- 11.4 times income
- 35 years old -- 10.6 times income
- 40 years old -- 9.6 times income
- 45 years old -- 8.3 times income
- 50 years old -- 6.8 times income
- 55 years old -- 4.9 times income
- 60 years old -- 2.6 times income
- 65 years old -- None needed
There's a fundamental assumption within these (as well as most) insurance numbers. The author suggests that income is equal to expenses/needs. That might be the case in most situations, but I'm in a different boat. I have a bit more flexibility when it comes to life insurance because my family's living expenses are well below my income. So the amount of life insurance we have on me is only five times my income but is over 15 times what we need to live on.
Furthermore, if we look at real needs even closer and try a more accurate estimate of what our life insurance needs to cover, we're quickly approaching the point where we will be self-insured and won't need life insurance. That said, I always err on the conservative side of things, so I have plenty of (pretty inexpensive) life insurance that will cover our family for another decade or so.
The Long-Term Care Ratio
The last ratio is the long-term care ratio and is designed to make sure you have the proper amount of long-term care insurance for your income at various ages. It works as follows:
- Determine your long-term care costs per year -- As an example, let's say they are $75,000 a year and you're married, so your total costs are $150,000 per year.
- Calculate your retirement income from all sources -- Let's say that you earn $100,000 from Social Security, savings, and investments each year.
- Subtract the income from the costs -- Based on our example, the difference would be $50,000 per year.
- To have a proper long-term care ratio, you'd need LTC insurance that would cover $50,000 or more in long-term care costs for you starting at age 55.
I'm not at the point where I need long-term care insurance, but I'll be writing about it in ten years or so. Any of you willing to stick around that long? ;-)
So what do you think of these ratios -- good or not so good? And where do you stand compared to them?
"Rules" such as this would be vastly more helpful if they didn't assume a family structure that is at present almost obsolete...
Most families these days rely on *two* adult wage-earners. Are you supposed to split the insurance recommended between the 2 adults? Do you use the higher or lower wage in your calculation?
Also more and more families with young children these days are split between 2 households because the parents are divorced. If one parent dies, he or she needs to cover what they would have paid in child support up until age 18 and possibly college costs plus some "extra", but unless you've remarried, you certainly don't need to cover your mortgage and household costs or the costs of maintaining a lifestyle for a non-working spouse.
Posted by: MC | May 20, 2010 at 01:32 PM
Your right MC. I don't have any kids. And I have no debt. If I died my parets would get most everything. I don't need life insurance. I think my employer gives one year of pay to my benificiary also.
Posted by: billyjobob | May 20, 2010 at 03:33 PM
I disagree with the life insurance ratio -- as life insurance should not be based on your salary. That is not the purpose of life insurance.
The purpose of life insurance, is to make sure any dependents you have will be taken care of. How much you need, is extremely situation dependent.
Even if you have dependents, if you already have a large nestegg, there is no need for life insurance, no matter how old you are or what your salary is.
I don't need any life insurance because I don't have any dependents and have a positive net worth. For anyone is single, I'd only recommend enough to cover your debts and funeral costs.
With dependents, I'd recommend enough to cover paying off your house (or enough to pay for a house in cash) plus X amount. X is whatever you feel would be enough to leave behind to cover expenses for awhile. Maybe that is 5 years, 10 years, 20 years??? Who knows, it will depend a lot of your current financial situation, your dependents and how old they are.
Posted by: Josh | May 20, 2010 at 04:44 PM
Count me as another who isn't terribly impressed with the life insurance ratio.
I have no family that depends on me. (wife or kids) If I die, my estate could pay my mortgage payments for about a year and a half with cash I have in the bank (if it had trouble selling the home, which is what it should do instead) My heirs (at this point, my parents, step-parents, and siblings) would have no trouble paying my funeral expenses. My folks could easily cover my funeral out-of-pocket if they couldn't get their hands on my money quickly enough for whatever reason.
I've got a 401(k) and IRAs, cash on hand, company stock, and equity in my house, all of which will go to my heirs. Why would I need life insurance?
That said, my employer provides twice my salary as life insurance, so assuming I die while still working this job, I'll leave my family quite a bit.
Posted by: MattJ | May 20, 2010 at 06:43 PM
I am insured for about 2.77 times my annual income which is 3.23 times our annual expenses, but that's because my husband is also insured and we can technically live off either of our salaries (we can live comfortably off of his and uncomfortably off of mine...that's why we use mine for savings pretty much). Plus, we don't have kids.
We don't have long-term care insurance. I was hoping to wait til our 40's or 50's to look into that.
Posted by: Budgeting in the Fun Stuff | May 21, 2010 at 01:26 PM
I have $15k in life insurance, of which $5k is provided by my employer. That will pay for my burial and leave a little over for my grown kids.
They are to bury me as I did my husband (I have this in writing for them) or cremate me. I do not want to be cremated, but I actually abhor the idea of being buried in a vault. God made the perfect recycling system for everything, including his children. Way to go, Father.
Posted by: Georgia | May 24, 2010 at 03:52 PM