Thursday, August 31, 2006

How much life insurance is necessary?

I read a recent posting from today pondering how much life insurance is necessary.

I've worked in and out of the industry and have some thoughts:

Do you need it and what to buy

1. Do you really need life insurance - do you have dependents or debt that might effect others?
2. Buy only term. 30 year is very close in price these days to 20 year.
3. Do you have a large estate that will be subject to estate / inheritance taxes?
4. Do you have business partners that would need the proceeds to buy out your spouse?

How much?

So much depends upon your age and obligations to others. These questions will probably not show up in an online-calculator:

  1. If you died today, would your spouse have to work or stay home with your children?
  2. How much of your income would your spouse need to provide for your children, retire and meet debt obligations like your mortgage?
  3. For how many years would your spouse depend upon the life insurance proceeds?
  4. Will the proceeds have to cover educational expenses for your children, such as college or graduate school?
  5. Will the expenses be needed for a wedding?
  6. If your spouse is not working or does not have health insurance coverage through their employer, how much will private or third party insurance cost - will their be enough left in the proceeds to cover the cost?
  7. Would you like to use life insurance to cover the difference between the estate tax exclusion and the amount subject to estate tax / inheritance tax?
  8. Do you have any contingent business, employment or investment obligations (advances, draws, business performance goals) that would create a liability to your estate and survivors; i.e. would they have to pay back any advances or have penalties on performance contingencies?
  9. Are there any planned large capital expenses that could not be afforded by your surviving spouse that must occur - home repair, surgery?
  10. Will a family business have to be shut down, sold off or supported?

Strategic thoughts

In general I'd rather be over insured than under insured. We have 30 year term policies. There was little difference between them and 20 year policies.

My accountant recommended as close to 20 times current earnings as possible. Why? My earnings will be increasing over the next 10 years. Buy the insurance now while I'm still young and healthy and it's still cheap. In 20 years my wife will have her hands full with college expenses. $1M, $2M even $4M today won't seem like nearly as much money 20 years from now. I used the calculator at to project what college would cost in 17 years - I want my kids to take a year off before going to college. Work would be good for them. I was amazed at the projected cost for a top flight 4 year private school (only 60% of students actually finish in four years - some take another year). It came to $500,000. Amazing. We're currently saving about $600/mo. for each child. Will my wife be able to continue that after I'm gone?

Based on discussions with underwriters, I think it's very difficult to obtain more than 20 times earnings unless you already have substantial assets - in which case you may not need insurance except for estate preservation techniques.

Here's another thought. A family business may need to have a key man policy on you in order to shut itself down or higher a president / general manager. Your spouse may want to keep the business or sell it off. You'll need to have someone run it and pretty it up for sale if that's a consideration.

Have a wonderful day,

PS If there's enough interest i can write a posting on estate preservation and trusts - let me know.


mOOm said...

Never thought of insurance in order to pay the estate tax. Well that is off in the future for me if it will ever be relevant. I just have the autmonatic life insurance included as part of all salary apckages with my employer. I think it is 4 or so times earnings. It has no practical use for me, except doubling my net worth dead rather than alive. We're then talking $630k well inside the estate tax limits currently. My mother lives in Israel where there is no estate tax (neither does Australia). Total net worth is just over the current US limit. Just need to make sure to not have too much in assets in jurisdictions that might decide to charge estate taxes. Like the UK where the limit is around £300k only.

makingourway said...

Wow, moom, I didn't know about the lack of estate tax in Australia and Israel. What a great deal. I wonder if you have dual citizenship - say with the USA - if the USA can make whole or partial claim to the estate or tax the beneficiaries?

I think the compelling reason to lock in an inexpensive term life policy is to save cost on premiums IF AND ONLY IF you have a strong certainty you will have dependents who need the income in the future.

The UK needs to ditch the £300k limit - very socialist.

It's very common to utilize insurance to cover estate tax - it's especially important to protect family and closely held businesses - hence the popularity of "key man" insurance policies. Without the insurance money, the heirs would be forced to liquidate the business.

Older people usually end up converting term policies to whole life at which point the premiums become less expensive - but still very expensive. The key formula is the determination as to whether the premium cost will be less than the estate tax.


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