Why Buy Life Insurance?

by Neal Frankle, CFP ®

If you don’t own life insurance – or don’t have enough life insurance – you might be asking yourself, “Why buy life insurance at all?” It’s a valid question. Let’s look at this together.

Disclaimer: I admit that I am a life insurance crazy man. I don’t sell much of it as a financial planner – for reasons I’ll explain in a minute. But I go nuts when people who should have life insurance don’t have it. I also go nuts when people get sold the wrong kind of life insurance. As you’ll see, inexpensive term life insurance is the way to go for most of us. I’ll get to all this. But first, let’s address the question of why people buy life insurance.

There are only two good reasons for people to own this coverage. The most important reason to buy this is to protect your family in case you or your spouse dies. The other reason is to pay estate taxes. (This impacts very few of us so I’m not going to address that issue here.)

Let’s get back to the main purpose of life insurance. If there are other people who depend on you to provide income that would not exist if you were to die, you simply must buy life insurance. There is no other way to create an instant asset pool that would replace your income other than life insurance. Life insurance doesn’t replace your income per se. It creates a big pot of money in case you die. Your beneficiaries take that lump sum and invest it for income.

The Reason I Take This Subject Personally

If you are a seasoned reader of Wealth Pilgrim, you know that both my parents died before I finished high school. My father had a small term life insurance policy in place by sheer luck. He didn’t have a plan and he certainly didn’t have enough to provide for 4 orphans. But he did have a policy and my share was enough to put me through college. (That was a very long time ago when it cost almost nothing to go to college. Don’t try this at home.)

I get triggered when I see parents with minor children who don’t have the right insurance and/or who don’t have enough. It just frightens me. That’s why I am a little nutty when it comes to this topic.

What is the right kind of policy to buy?

If you are interested in protecting your family for a specific time period (and you should be) only buy term life insurance. I’ve written extensively about term vs whole life. Whole life is terrible for family protection. Why?

Because whole life is so darn expensive that people buy a lot less insurance than they need. It gets sold as an investment (which it is not) and the family goes unprotected. That’s one reason why I can’t stand whole life. And it’s why I get into so many arguments with whole life agents who buy big fancy cars with the whole life commissions they make. But I digress.

What is the right amount of coverage to have?

Once you conclude that you need life insurance, you need to know how much term life insurance you should buy. A good rule of thumb is 15 to 20 times your income. This assumes that your income is great enough to pay your bills and put aside a sufficient amount for retirement savings.

When should I buy the term insurance? How long should I own it?

If people depend on your income right now then you need life insurance right now. You won’t need it once either of the following two conditions is true:

a. Your dependents become independent.
b. Your investments are large enough to replace the income that stops coming in once you die.

Who doesn’t need life insurance?

If nobody relies on your income for support, you don’t need life insurance. Also, as I said above, if your assets provide enough income to support your dependents, you don’t need insurance to protect your family (but you might be in the tiny minority of people who need estate tax protection offered by whole life).

As said at the start of this post that I don’t sell much life insurance. That’s because most of my clients match the description above. Their assets are large enough to self-insure and/or they no longer have dependents. But I’ll guarantee you that the first thing I talk about with younger clients is life insurance.

If you don’t own life insurance, why not?

Note: This post is part of a campaign spearhead by my buddy Jeff Rose of Good Financial Cents. The goal is to raise awareness of the need for the right kind of life insurance by readers of personal finance blogs.

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