Death is something that no one likes to think about. We’re all going to live forever ever, right? Of course not, but when do you need life insurance?
A reader wrote in to Ask Carly to find out.
Ask Carly is a way for us to stay connected and support one another on our journey to gaining financial independence. It’s a judgement-free place to get some solid advice, because, you don’t need to figure this money stuff out on your own.
“My husband and I bought a house based on both our incomes, I’m thinking it would be the responsible thing to do (to get life insurance). However, I need to do more research. Any insight is appreciated, like if/when we should get it, other options to consider, and the range of prices to expect.”
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Let’s take it from the top with what life insurance is.
Life insurance is to replace income if there is a death. In exchange for paying premiums monthly the policy pays a lump sum upon a death.
The moment you get married and/or have a child, you need life insurance.
It’s a personal finance must-have.
With a spouse and/or child, someone depends on you financially. You have what is called dependents and you need life insurance regardless of being a homeowner or a renter.
Life insurance is needed until you and your spouse have asset that are large enough to generate income to cover household expenses. You need coverage until children are self-sufficient (at least 18-years old, or through graduating college) and don’t depend on you financially.
The good news is, you do not need it forever.
There are two basic types of policies: term and permanent (also called whole life).
Term policies are the simplest, least expensive, and most widely accepted form of life insurance, according to Forbes.
Term policies have coverage over a set number of years or term like 10, 20, or 30 years.
Permanent life insurance has lifelong protection, and has an investing component, or a cash-value with the policy. Cash-value means that if you stop paying your premiums and without a death you can get money back from the policy.
This sounds appealing, but the drawback is these policies are more expensive. You may have heard the phrase, “buy term and invest the difference.”
Get a lower premium with a term policy and the stock market historically performs significantly better than your insurance policy would.
How much life insurance do you need?
An old rule of thumb stated to get a policy that has a payout of at least 10 times your income. If you make $100,000, then you’d want a policy for $100,000 X 10, or $1,000,000. This rule of thumb doesn’t directly take into consideration factors like your current debt load, or mortgage.
A more comprehensive rule of thumb for coverage is the DIME formula.
DIME calculates needs based on the following:
Debt and final expenses- add the total of your debts excluding your mortgage, but including your student loans, car loans, credit card debts, etc. and an estimate of funeral expenses.
Income- decide how many years your family would need financial support and multiply that number by your annual expenses. For example, if you have a two-year old, you’d want financial support for 20-years, or until they’d graduate college.
Mortgage- the total amount owed on your home.
Education- an estimated cost for your children’s education.
With DIME, you’d add the total coverage needed based off your debt, income, mortgage, and education.
How much does it cost?
The price differs greatly if you get a term versus a permanent policy. The price also depends on your age, if you’re a smoker, and the total dollar value of the policy. Also, with a term policy the monthly payment is guaranteed and the same for the entire policy. Keep in mind, the younger you buy your policy, the lower your premium will be.
Here are examples of quotes and pricing.
20-year term million-dollar policy is:
- $29.90 a month for a 30-year-old nonsmoking male
- $105.10 a month for a 50-year-old nonsmoking male
30-year term million-dollar policy is:
- $49.02 for a 30-year-old nonsmoking female
- $173.35 for a 50-year-old nonsmoking female
When buying a home, you’ll often hear about mortgage life insurance, which pays off the balance of your home if you pass away. The idea is that if one spouse passes away, the rest of the family would not have to worry about paying the mortgage.
Term insurance is usually a better choice because it covers more than just paying the mortgage. Plus, with mortgage life insurance your benefit declines over time as you pay down your mortgage. The one scenario where mortgage life insurance makes sense is if there is a pre-existing medical condition that prevents you from being approved for a term life policy.
In a nutshell: yes you do need life insurance.
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