I know, this is a financial topic most families would sooner avoid. Who wants to purchase a financial product designed around the likelihood of one’s premature death? It’s hard enough for families to talk about money, now they need to talk about money AND dying? No thanks!
The fact is, life insurance is an essential part of any financial plan. The risks of not carrying it are too severe. An unpaid mortgage, outstanding personal loans, future college expenses for your children. These and other expenses are easier to handle when your family has a steady paycheck coming in. But what if you died and those paychecks stopped? These and many other obligations still require payment.
I think you get the point. Life insurance is important and almost everyone should have some. Where many people get hung up is they make purchasing insurance too difficult. Your goal should be to get at least some coverage. I say some, because a lot of Americans have none. A recent study by Bankrate found that over 40% of respondents have no life insurance at all.
What is Life Insurance?
The concept of life insurance is pretty simple. Life insurance is a valued contract, meaning there’s monetary, economic value attached to the agreement between you (the insured) and whoever you buy coverage from (the insurer). When an insured person dies, the beneficiaries of the life insurance policy receive the face amount of the policy.
How Term Life Insurance Works
There are two broad types of life insurance: term life insurance and whole life insurance. Whole life insurance policies have their place, but they’re more complicated than term policies. In the interest of helping you get some life insurance, I want to make this simple, so we’ll stick with term insurance for now.
As the name suggests, term life insurance is valid for a certain period of time, such as 20 or 30 years. During the term of the policy you make level premium payments (meaning your payments don’t go up or down) either annually or monthly.
As an example, assume you are 35 years old and in reasonably good health. You may find a term life insurance policy providing $500,000 of coverage lasting 20 years at a monthly premium of $50.00. You pay your fee each month, and if you die within the 20 year term, your beneficiaries receive $500,000.
Assuming you’re still alive at the end of the policy term, the policy expires. More term insurance can be purchased, but you’re older now, so it will cost more.
How Much Life Insurance Should You Purchase?
This is usually where people give up. Understanding how much life insurance to purchase can measure “Rubik's cube-like” on the difficulty meter, depending on what factors you choose to consider. The American College notes several approaches to determining your required coverage, including:
- Human value life approach
- Multiple of income approach
- Financial needs analysis approach
- Capital needs analysis approach
It can be a mind-numbing process, unless you’re into that sort of thing. But again, this shouldn’t be a complicated decision. As I mentioned, the goal of this exercise is to get you some coverage.
The most straightforward way to determine your life insurance needs is the multiple of income approach. You simply take a certain number (the multiple) times your annual income. What’s the multiple? Some financial journalists, according to The American College, suggest five to seven. So if your annual income is $50,000 your should purchase a life insurance policy amount of $250,000 (5 x $50,000) to $350,000 (7 x $50,000).
New York Times financial advice columnist Carl Richards suggests using 20 as your multiple. Obviously you’ll end up buying a lot more coverage.
The purpose of this post isn’t to walk you through an in-depth process for how to determine the right coverage amount for you. If you want to calculate it, shoot me an email and I’ll send you an outline for each approach. Just know that as life happens, the amount will likely change.
If you’re uncovered and want to become part of the 60% of folks who have at least some coverage, multiply your gross salary by seven and go buy some life insurance.