You may have noticed that on my income and expenses that I pay for Life Insurance. Its not that I expect to die, but if I did, I don’t wish that my wife or I would be burdened with debts that one salary cannot repay. Now once our accessible funds passes our debts I would feel safe in cancelling our policy. This is one of the many ways that past financial decisions can haunt you and even though we pay about $44 a month for the policy, it is $528 every year that can be cut from the budget… eventually.
Now, what do I mean by “accessible funds”? To me, my accessible fund’s is money in a brokerage account, checking, savings, and contributions or conversions to a ROTH IRA that you can withdraw. Once these amount exceed the debt levels I will feel safe about cancelling the life insurance policy because I know worst-case scenario that my wife can kill off all debt and be able to get by financially.
How much life insurance do you actually need?
This is kind of a personal topic and you need to decide between everyone involved just how much, if any, is needed. My wife and I decided that we would like enough coverage to be able to clear all debt if one of us passes away. A life insurance company will try to fear you into needing more life insurance than necessary in my opinion. Basically all calculators such as the one at bank rate and life happens are saying you need to replace the income lost and set aside amounts for debts. But if you are wiping out all debt and thus decreasing the need for cash immediately and in the future why would you assume you need a full income replacement? Plus, in this conversation, I rarely see it mentioned that the social security administration offers survivor benefits if you have a minor child under age 16. Not to mention that income replacement is a bad way to go. There are costs to obtain an income such as taxes, gas, insurance, car repairs, you name it.
If you take control of your financial life early, you shouldn’t need to worry about having debt past when your kids are age 16. Heck, you could possibly be debt free BEFORE you have kids. So if you take have an early start you could probably avoid needing life insurance at all or use it only for a short time while you finish paying off debts. I probably won’t be getting out of debt before having kids and if you happened to glance at my net worth you would know I am sitting over six-figures in debt including the mortgage.
So why do you say it is a penalty of debt?
To me it is a penalty of debt, but in reality, it is a penalty of wanting things before you can own them. If I had fully paid for my car, my house, and my wife’s education then our cash flow would be about $950 more a month. Just that plus costs for another person traveling to work are easily $1,100 a month in after tax dollars. Being this is all after tax and our highest marginal income is getting deducted at almost 27% when you count FICA, federal, and state taxes, that our be the equivalent of $1,500 less earned income a month needed. That would make things manageable for the surviving spouse, although savings would not be as robust, either one of us should be able to retire at the “normal” retirement age. So besides losing the each other, we may lose that luxury. But what would be the worst case?
The Worst Case – Cancelling then Dying
Worst case could be if I cancelled the life insurance as soon as we reach enough in accessible assets to pay off the debts. Now when we got our policy we didn’t have group coverage at work, but now we are both actually given $30,000 in life insurance. So my formula would be this:
Debt = Free Life Insurance (30,000) + ROTH IRA Contributions + Brokerage Acct + Checking/Savings
I expect to be at this point at in ~5 years, at which point I will feel confident cancelling the life insurance policy and using the excess to accelerate investing or debt pay off. So if I were to cancel this policy 5 years from now and then die the next day, how would that leave my spouse financially in today’s dollars?
Savings
- All of the gains in ROTH accounts
- Entire balances of 401(k)’s and pension
- Paid off house
- Just the balance in the checking account not scavenged
Take Home Income ~ $25,000
Expenses
- Car, Insurance, Maintenance, Gas ~ 2,700
- Home Maintenance Fund ~ 1,800
- Home Taxes and Insurance ~ 2,900
- Utilities ~ $2,200
- Food & household items ~ $3,500
- Gifts, Misc, and Clothing ~ $1,300
- Entertainment ~ $600
Total Expenses ~ $15,000
And I think I am being a bit generous on a couple of categories for our normal expenses. Now you may ask, what if we have kids at this time? Well she would then have the ability to collect social security survivor benefits offsetting the cost of childcare and other expenses that they may incur (until they are age 16). The thing is without debt (and no kids) we could probably be living on an income level like this once retired. Some areas may shift from car costs to health insurance as we won’t be driving every day, but the reality is that I can look at my expenses and say “yea we can live on $15,000 a year and that counts saving for major house costs” is pretty awesome. Granted this won’t be the reality if kids enter the picture, but one day when they are gone it will be. Then all of the excess income can be for hobbies we enjoy and traveling. Ahhh just thinking about retirement brings a smile to my face and I’m only 27!
What about you, do you have life insurance?
Photo Credit: dan/freedigitalphotos.net
I don’t have life insurance, but definitely thought about it. I think there are two main types: whole and term life insurance. Dave Ramsey say that term life insurance is the best way to go. I haven’t done my research so I can’t say. But which type of life insurance do you have? Do you happen to know the pros and cons of each? Thanks.
Cheers!
Hi Henry,
Whole Life Insurance is kind of like a savings account plus term life insurance. Eventually you will fully fund your insurance (age 100) and you will have the entire value of your insurance. But you pay a MUCH larger amount for this insurance. And if you want to take your own money it is a loan in which you pay interest and will decrease the amount your insurance will pay out if you have a loan outstanding. Typically it is said it is better to get term and invest the difference.
Term life insurance is basically a set amount of coverage for X amount of years. It could be a guaranteed rate for those years or it could ladder and increase every so often.
Alot of work places offer group insurance coverage which is like term life insurance that ladders as you age. One thing is if you leave your employer and if you need to keep the coverage I think your only option is going to the whole life (which is costly).
There are a couple other hybrid investing types of insurance that exist as well, one called universal life. But regardless term is usually the best way to go unless if the individuals spends all of their money… then some forced savings may actually help them.
Kipp
Kipp,
$44 is a lot of money each month for something you hopefully won’t need, but considering the peace of mind it gives you and your family if something were to happen to you I would also take the life insurance.
I don’t have life insurance myself because nobody depends on me and I don’t have any debt, so there hardly is any ‘collateral damage’ (financially speaking of course) when I die.
Have a great day,
NMW
Hi No More Waffles,
Oh I hope I would never need it! It is basically $22/person a month (since both my wife and I are covered). I can’t wait to clear out enough debt to no longer need this, but for a few years it is good to have a “just in case” policy. I may look and see how much the group coverage are at work and see if that would be enough coverage and cost less than what we currently have to decrease the expense a little. Problem is open enrollments are different dates so we would have to carry both for a couple of months until my wife gets coverage.
You have a great day as well, thanks for stopping by!
Kipp
Very timely post for me Kipp. I was actually reading a post over at Wise Dollar yesterday that got my gears turning on life insurance. I’ll be doing some shopping today, so these tips will definitely come in handy!
I just saw their post today, I thought that was kind of funny. I know some about the different options of life insurance, but term for most people is the way to go as I mentioned to Henry. Whole life (or universal) is really just good for people who can’t save money otherwise.
Group insurance also may be a good option and I may look into that this upcoming open enrollment, but the great thing about an individual policy is you can lock in the price at your current age and it doesn’t matter if you leave your job, you can keep the policy.
Basically the key is to make sure that the surviving spouse can continue to maintain the same standard of living. If you can clear out all of your debt, it won’t take much income to maintain that standard.
For some reason when I think of debt I somehow ignore the only debt I have, my mortgage. Society has me trained to believe that it’s good debt so it’s okay. Due to the fact that I can write off the interest in taxes does help but I still seem to have a blind spot for it. I never would have thought about having a life insurance policy to pay off that debt, but if I had other debt then having a life insurance policy to wipe that out would make sense.
I think that some situations differ, say someone is a stay at home parent who watches the kids while the other makes 100k per year. If the high earner dies then you have to replace more than just debt, you need to figure out how that other person is going to get back in the workforce and pay for someone to watch the kids on occasion. Also if the stay at home parent dies then you have to suddenly cover child care costs that were absorbed by the other person. Though having enough money to pay off your mortgage would soften the blow quite a bit, but it’s situational I think.
The only person that depends on me is my dog and I know who would take care of her. Not having anyone rely on my income makes things pretty simple so there’s no point in life insurance in my mind. I also have enough saved that it could easily cover whatever costs it might take to clear up my final costs.
Hi Zee,
Yes it is a highly personal thing and as you said situations are different if one person is a stay-at-home parent. But don’t forget you also have the survivor benefits to help pay for the daycare costs you may incur. I am sharing what our thought process was as a dual-income family currently with no children and how our plan will work even if children enter the picture.
I think that the mortgage write off is way over valued. For couples the standard deduction is fairly generous, but I see the value it brings for individuals. We will probably get just this year as our only year for itemizing. It is just not that great of a deal if you don’t over spend on a mortgage.
I agree that single people probably don’t need to worry about life insurance, but I don’t want the wifey to have to not only lose me, but the place she lives or the car she drives if I would die this moment. So for a few years I am willing to pay the piper for that “protection”.
I worked in the mortuary industry for 7 years (my husband is still a mortician), and I learned how important life insurance is during that time. Even having a small term policy can make a huge difference to your family.
Oh yea, I am not saying to NOT have life insurance. I think that you really need a grasp of your financial situation and how things will play out if one spouse were to pass. You need that financial snapshot if you will.
On the flip side, for most people, I don’t see why you need income replacement for 5-8 years AND enough to pay off debts. That will probably just cause you to over-pay for protection (but Zee brings up a good point that a family with a stay-at-home parent may need this).
You just need a plan that makes sense to the people involved and know when it is no longer necessary so you aren’t paying for something that is no longer needed.