You may not need life insurance. Plenty of people don’t. But when I meet people who should have life insurance and don’t I go nuts. I also go nuts when people get sold the wrong kind of life insurance. I’ll get to all this. But first, let’s address the question of who should buy life insurance.
Why Buy 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 prematurely. 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 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 life insurance vs whole life. Whole life is terrible for family protection. Why?
Because whole life is so darn expensive that people often 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.
Where should I buy life insurance?
The best place to shop for insurance is with an agent who represents many different insurance companies. Stay away from captive agents because they aren’t objective. I broker who deals with hundreds of insurance companies doesn’t care which company provides the coverage and that’s strongly in your favor.
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).
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.
Laz says
I am self employed and my business is selling real estate full time i currently own 2 whole life policies one for me and my wife paid up at age 65 with a disability rider. Each policy is 15k a year thats 30k a year for both policies I’m 35 and she is 25 we have 3 kids 4, 5, and 11 I have been paying in for approximately 2.5 years and combined cash value of 22k. That does seem like a huge amount of my money has disappeared and none of my contributions have served to reduce my tax liability, however what keeps my making the payments is the cash value build up by 55 years of age and the death benefit god forbid something went wrong. We are making only one other type of investments i.e. real estate but when I considered to diversify and a protection vehicle for my family whole life seemed like a good choice, in one hand it allows for cash value build up via dividends per my illustrations the benefits really start showing up in 20 years paying consistently. This choice did not take much hesitation when i started paying but I will acknowledge that paying this each month and the variances in what I have paid in versus my actual cash value is disappointing especially when you consider you have to borrow the cash value from yourself and pay 8%. Most recently my financial advisor with NWM said I needed to start buying insurance for the children that the benefits I can pass on to them would be life changing he said to me how would have I benefited if my parents passed to me a policy so inexpensive with significant cash value when i was just starting my financial independence. So I gave in! Thinking and convinced! that this would be a good choice! A policy that I could pass on to them at a low fixed premium and some cash value that could be applied to collage, maybe a wedding, or even a down payment on a house. I am at a crossroad I don’t know if I should bite the bullet close the policy retain as much of the cash value we have than purchase a term policy for me and my wife and also cancel the policies for the children that I just opened last month take those same funds and open a 529 savings account for each of the children and the 30k imam paying in the policies buy more real estate. The ultimate goal is to do something for the kids future and our retirement plan. Your perspective would be appreciated.
Neal Frankle, CFP ® says
Thank you. This is a bit much to respond to. If you like, I’d be happy to have a quick call with you to discuss further. Please email me at neal dot pilgrim at gmail if you’d like to have a talk. Thanks.
Maggie says
Hi Neal,
I have had an indexed universal life insurance for a little over three years now. I’ve put in about $15,000 and the cash value is a little over $11,000. I’m considering terminating the policy and instead getting a term life insurance and investing the rest on a 403B or 457 plan. However, I’m just a little weary because this would mean that I just basically lost $15,000. I called the insurance company and they said that I can continue to pay $142/month if I don’t want to lose the cash value. But I’m wondering if I should just cut my losses now and just terminate the policy completely and do the term life insurance plus retirement plan instead. What would you recommend?
Neal Frankle, CFP ® says
Thanks Maggie. I can’t provide specific advice because there is a lot more to know about you and your situation. But generally, you have to look at where you want to be 5,10 20 years from now, and how long you really need the insurance for. It sounds like each you lose money. That being the case, you might consider cutting your losses short after replacing it with term. Again, I am not recommending this strategy but it’s something to consider. For you to really make a decision Maggie, you have to think about your health, how long you need insurance, what the purpose of the coverage is, what the alternatives are etc. That means, and I’m sure you are sick of hearing me say this – you should really do an overall plan before making such an important decision. Thanks.
Noel says
Neal,
You are spot on with Whole life and term coverage, still there is one point why some may end up with whole life, instead of term, like me.
I have Ulcerative colitis and I take utmost care that I do not end up flaring. In my last 8 years since diagnosis, I haven’t been to the hospital for this disorder. Many wonder how. That being said, when I started shopping for life insurance, my premium cost was almost 4X DWs, just because of my UC. DW’s premium is $365/year for $500K (and she is 2 years younger than me, no health issues) The reason offered, I am in high risk category for colon cancer, the statistics from the 70s, still the insurance companies prefer that statistic. So I ended up with Whole life (Universal) in case of Guardian.
Term insurance – $1450/year for $500K coverage, 30 years = 43,500
Whole Life – $1777/Year for $500K coverage, 20 years = 35,540 Whatever I will earn on this amount is enough to pay next 11 years, as per the projection.
The agent ‘convinced’ me that this is my best option. As layman as I am, I got Whole life. Did I take correct decision or have been duped?
Theresa says
What would be the right kind of insurance to buy for a 51 year old woman.Just wanted to leave my adult daughter something for investment for her future.
Neal Frankle says
Hmmmmm……I would need more information. In this particular case, permanent insurance might be the way to go but there are other factors. If you like, drop me a line at Neal DOT Pilgrim AT Gmail DOT com. I’m happy to discuss this with you.
LilDot says
My mother does not have enough insurance on my Dad, there is little savings and no property of substantial value.
Neal Frankle says
I get it, but why do you need insurance? Will they be leaving debts?
Little Dot says
Hi Neal. Thank you for the wealth of knowledge provided in your newsletter. Regarding life insurance, I recently discovered that my mother who is 76 has an extremely insufficient amount of insurance on my dad who is 81. As the eldest and the only financially sound out of 4 kids, I’m almost certain that everything will fall on me and my husband. I did some research and found that there were limited options for my dad because he is past 80. I found one company but the monthly premium was a car note. Other carriers pounced on my mother and I so hard that I had to stop answering the phone for a time. Any suggestions?
Neal Frankle says
Try this post – but I fear you may find this difficult. Why do you feel your parents need insurance?