Yesterday I was chatting to a friend of mine on the phone; many friends gossip or make trivial arrangements. But I am a personal finance blogger and had just looked at out budgeting spreadsheet…so I mentioned how proud I am that couple of years ago managed to get higher insurance cover (rather high, actually) at much lower price. My bragging was caught short when my friend (who incidentally is a professor of accounting) said:
‘Why do you need all this life insurance? I don’t have any – it is waste of money.’
How our conversation continued is a private matter. What is important is that this made me think: death is not an uncertainty. If anything it is one of the few certainties in life. When deciding to take out life insurance, however, the uncertainty we are hedging against is the timing of our demise rather than the event itself. This timing would be a disaster only when our circumstances are such that we are likely to leave behind financial frailty; and do notice that I am not saying ‘mess’ but frailty.
Identifying the points of your financial frailty will help you not only whether you need life insurance but also would allow you to calculate the level appropriate for your situation. Let me use as example the points that I used to decide how much life insurance I will buy.
You position as earner
This is absolutely vital for your decision. If you are the primary earner in the family you need insurance; and probably quite a lot of it. Irrespective of whether you have children or not, it is your duty to make sure that your partner has the means necessary to maintain a decent life style.
In my case, I have been the primary earner for some time now – although John also earns well, most of it is fairly uncertain coming from contracts. Check!
Age
This is a bit tricky one. On the one hand, the older you are the less insurance you can afford – it is probably not that good for the ego but after a certain age the probability of decease and death increases so much that the cost of insurance becomes prohibitive. On the other hand, you still may have dependents that rely on your income and case. In such situation it is probably better to save or invest a similar amount.
The age of your partner also plays – having an older partner makes it prudent to buy generous levels of life insurance. After all, being younger you should expect to hit a time when you support your partner.
Children
There is no doubt, no hesitation about it: if you have children who are not in their late teens yet take out life insurance – enough to get them through school, university and help them have a half decent start in life.#
Mortgage and other liabilities
If you have mortgage and other liabilities it is wise to take out life insurance that matches or exceeds their value.
Check…
…whether you need to take separate life insurance or you have some through your pension. Do the calculations carefully – you may already have life insurance through your pension (I do) but it may not be enough.
This brings me to the matter of how much life insurance is enough – being over insured is not as serious transgression as not being insured but still…
How much life insurance is enough?
To decide how much life insurance to carry, I did the following:
- Calculated all our liabilities
- Calculated how much John will need to live on and raise our son
- Checked the conditions of my pension
The amount of life insurance I have is
(Total liabilities + £100,000/$160,000) – insurance through pension
My calculations show that this, and the pension that John and our son will receive were something to happen will be more than enough.
We used the same logic to calculate how much insurance John will carry.
How do you decide?
That’s a good decision. I’ve seen figures (sorry, can’t remember where, now) suggesting that many people hold far too much cover.
We have no debts, no mortgage and no-one dependent on us so we don’t carry any at all!
@Pat: It still may be worth looking into – see, I added £100K on top of liabilities (and Philip will get a pension from me if I go). This was calculated to give John about 10 years without worry about money and the need to sell stuff (like his home which he may or may not wish to do).
I have practically no debt so I used income replacement. I wanted 10 years of income for my wife and I. I have a term policy on her and she on me.
@Krant: Agree! Except that with my calculation it was more income addition than replacement – the £100K are to add to John’s regular income (his pension) and allow him breathing space to decided what to do; not be forced in action because he can’t cope financially. As I said, the decision is about what we want for the ones left behind after we are gone.
I personally don’t have any right now because my assets exceed my liabilities by a healthy amount and I don’t have kids. The second I find out I’m having a kid I’m getting insurance.
@Lance: Probably still worth having a bit – on you and you partner. And at your age it is likely to be rather cheap.
What a tease you are: starting with an interesting story and then stopping abruptly!
I agree. If you live long enough, then you will leave this earth at some point. To not be prepared is irresponsible. It is generally that simple.
@Roshawn: Ha, ha! The conversation with my friend took an iteresting turn – I continued insisting on life insurance and she kept going on about it being a waste. Then she did say that they are apying off the mortgage (a large house worth close to £1 million) and I remembered that there is life insurance as part of our pension arrangement (university lecturers in the UK still have quite good deal on pensions). As usual with PF, in her case it would have been a waste but not because it is not important but because she already had it. Im my case this was not enough because I would be leaving a young kid behind (and a mortgage if something happens within the next four years or so).
I have to admit I’m a bit unsystematic about how I chose the amount of life insurance we have. But I do like your strategy.
@Barb: Thanks! We did discuss this one for a long time and used the same logic to decide how much John will carry.