Q: I am the father of three. I have a $100,000 life insurance policy through my employer, but I am sure this will be a drop in the bucket assuming this bucket gets kicked. What do you recommend?
$ ?s answered by Matthew Illian, CFP®
Term life insurance is so affordable that no one has an excuse to be underinsured. Over your career, make it your objective to save enough so you no longer need any life insurance. Those who accomplish this goal are self-insured and no longer need to pay a third party. But until then, life insurance provides great peace of mind.
Some suggest using ten times your take home salary as a rough rule of thumb when determining life insurance. Like all such rules, this rough guide is found lacking in many situations. Term insurance is cheap, which means it’s always better to overestimate when assessing your own needs.
To calculate your own estimate, start by adding up all of the expenses you would like covered in the event of an untimely death. Here are six typical line items to consider:
Consumer debts: The baggage of debt makes the journey to financial freedom difficult. Avoid debt if possible, but if you have any, don’t burden your family with it after you are gone. (Estimate: ~$4,000)
Mortgage: Paying off all debts is not a requirement, but it offers peace of mind to know the funds are available if this choice is preferred. Those who locked into historically low fixed interest rates will often find it beneficial to use these funds to make minimum payments. (Estimate: ~$150,000)
Educational expenses: When the children are school age, will you want them to attend private school? My colleague Bob Arms wisely counseled me to plan for private school even though my children are now enrolled in public schools. The surviving parent might want the option of joining a more close-knit community. (Estimate: 3 children, $13,000 per year, 6 years each: ~$234,000)
What about college? Some parents expect to foot the entire bill and others expect their children to participate. Four-year costs for in-state tuition, room, board, books, and transportation presently average $85,788 and a whopping $168,896 for private colleges. In 18 years, you can expect both numbers to more than double. (Estimate, 3 children, in-state, 85% of costs: ~$220,000)
Family income: Aside from paying off debts and a fund for educational expenses, your family will need additional income to pay the bills. If your children are young, the cost of child care may make it impractical for the surviving spouse to return to work.
You can estimate your standard of living by considering the amount of your paycheck that does not go into savings. Replacing income that covers these monthly expenses is essential. I recommend that you plan to cover these expenses until your youngest child is at least age 15.
Some of this need can be offset by survivor income provided to young widows and dependent children by Social Security which can be up to 180% of your projected retirement benefit. You can find this benefit listed on your Social Security statement and you will need to add up the benefits for each family member not to exceed the Maximum Family Benefit amount that is listed. ($50,000, 15 years, net present value, ~$600,000)
Final expenses: This is never a nice thing to think about but burials are not cheap. Around $10,000 will be enough to cover funeral costs.
Fudge factor: No one can forecast the exact amount a surviving family will actually need, but this category does absorb a potential miscalculation. Most gaps can be filled with 10% of the total of the other five items. (Estimate: ~$120,000)
Total estimated needs: $1,338,000
Now subtract your current assets from this estimate of future needs. Include only the assets the surviving spouse can use for expenses. This means you need to exclude your house because your spouse needs some place to live; your car because transportation is essential; and your retirement assets, which the surviving spouse will need during retirement. Nor should you count any inheritance. The old adage is true: Don’t count your chickens before they hatch. You can always drop a policy if the situation changes in the future.
Do include your existing life insurance policies, investments accounts, college savings accounts, and equity in business or real estate investments. Subtract these current assets from your future expenses projections, and you now have an estimate of how much additional life insurance to carry.
You can request quotes from brokers who work with several companies to compare rates. Or work with a fee-only financial advisor who can coordinate comparison shopping for you. The key is to avoid getting talked into a policy with features and benefits that will turn your act of love into an expensive burden with high premiums.
After working with hundreds of wealth management clients, we have yet to recommend a life insurance product other than a basic low-cost term policy – one that generally lasts until your youngest child is close to graduating from college.
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