How Much Life Insurance Do I Need?

Last year, I switched my car and home insurances to Liberty Mutual and started an umbrella policy with them as well. This move netted me a saving of over $1,000 per year and allowed me to pay the premium monthly without any fee. Last week, I agreed to meet with the sales agent to discuss life insurance policy. Although, I already carry a term life insurance policy through my job that pays 7 times my annual salary in case of my death, I am always looking for better option.

In this part one of the series, I’d like to go over the process that I went through with the sales agent, which I felt was interesting and educational. In part two, I will go into my mathematical analysis to determine what type, if, and how much life insurance I should buy.

Life Insurance Needs Worksheet

To determine how much coverage my wife and I should buy, we completed the Life Insurance Needs Worksheet.

The worksheet examines the 4 general factors:

  1. Date of Birth – As we get older, life insurance becomes more expensive, because of (1) we are more likely to die, and (2) there’s less payments for us to make (i.e., in case we buy whole life insurance where we pay the premium until 65).
  2. Gender – Even if my wife and I are the same age, her premium will always be lower than mine because (1) women live longer on average and (2) men have more risk factors.
  3. Health – There are several health classes for Liberty Mutual — e.g., Elite, Premium, Standard, Sub-Standard, etc. People with the best health profile gets the best rate. The sales agent felt that my wife and I should be eligible for Elite because we are of average weights for our heights, and our blood pressure and cholesterol levels are normal.
  4. Smoking vs. Non-smoking – This one doesn’t need any explanation.

The worksheet also examines 7 specific factors:

  1. Final expenses fund – This is the amount we need immediately to cover final expenses — e.g., funeral plot, embalming, casket, etc. He estimated this to be about $15,000 per person. Brip Blap has a good piece on preparing for the cost of dying.
  2. Emergency fund – This is for unexpected bills and expenses. I thought it was strange that emergency fund was included in the worksheet, and the sales agent did in fact said to skip and ignore it. Personally, I believe everyone should have an emergency fund, and it shouldn’t be part of your death benefits.
  3. Outstanding debts – Although outstanding debts usually go away with the deceased, there are some shared obligations that the spouse will have to bear. For example, credit cards, installment credit, auto loans, etc.
  4. Mortgage and rent payment fund – This is the mortgage payoff amount, or an amount sufficient to cover 10 years of rent.
  5. Education fund – This is meant to partially cover my son’s college expenses. The agent recommended $100,000 to cover 4 years of public college, but I believe this amount should be closer to $250,000 — however, I did stick with his suggestion for this exercise.
  6. Income Replacement Fund – This is the extra money to keep the living spouse, or the beneficiaries afloat for a few year — it’s not meant to be a lifetime income replacement. The recommended amount is five years of current income. However, the sales agent said two years is the minimum, and that’s what he recommended we start off with.
  7. Current liquid assets and life insurance – This is the amount of assets that can be readily convert to cash. For our purpose, the sales agent recommended that we exclude the term life policy from my job, my 401k, and our IRAs.

Once we completed the worksheet, it was a simple addition of #1 through #6 and subtract #7. It turned out that I should buy $380,000 to cover my wife and our son, and she should buy $290,000 to cover me and our son.

Options and Premiums

After we determined the coverage amount, we explored the following options for term life insurance, and the associated monthly premium.

Description My Policy,
$380,000
Her Policy,
$290,000
20 years term, elite $30.69 $20.58
20 years term, preferred $37.53 $22.93
30 years term, elite $47.45 $28.94
30 years term, preferred $61.81 $33.63

He also recommended that we look at whole life policy as a supplement to the term life policy. However, he suggested a smaller amount like $50,000 to $100,000 to supplement our term life policy. I appreciated that he openly said buying any more than that in whole life is just a waste of money. Here are the options:

Description My Policy Her Policy
$50,000 whole life – pay to 65, standard
(there’s no elite option)
$65.16 $41.27
$100,000 whole life – pay to 65, elite
(minimum coverage to qualify for elite)
$115.00 $67.95

Interesting Points

Our conversation brought up a few interesting points, not all of which we have answer to.

  • When I mentioned life insurance through work, the sales agent made a good point which I agreed with: the policy ends when I lose my job — and life insurance is something I don’t want to be without.
  • The sales agent mentioned that, on average, Americans buy 7 life insurance products through their life time to supplement, or replace existing one.
  • Life insurance payout is tax free to beneficiaries. This means that you’ll need less coverage to replace loss income. For instance, if you want to replace $100,0000, you’ll probably need only $80,000. Here’s a nice marginal tax rate calculator.
  • If we can’t qualify for elite, the sales agent suggested waiting a few weeks to get our stats in order. As you can see it’s worth the wait for the differences in saving. Similar idea was expressed on Consumerism Commentary.
  • If I die, what happens to my 401k? I did name my wife as the beneficiary, and our son as the contingent beneficiary. I am not quite sure how to answer this myself.
  • Similarly, what happens to my IRA?

In the second part, I will be doing some mathematical analysis and share my decision with you. While you wait, here are some other good articles about life insurance:

Other articles in this series:

Get your life insurance quotes now, or you can also check out these list of insurance companies that can provide you with free quotes:

About the Author

By , on Feb 26, 2008
Pinyo
Pinyo is the owner of Moolanomy Personal Finance. He is a licensed Realtor specializing in residential homes in the Northern Virginia area. Over the past 20 years, Pinyo has enjoyed a diverse career as an investor, entrepreneur, business executive, educator, and financial literacy author.

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Leave Your Comment (14 Comments)

  1. Joshua Schneiderman says:

    As an agent, I have some slightly different opinions regarding life insurance. I believe in income replacement, or in the case of a career homemaker, securing the money that would be required to replace those services. I would add onto that final expenses. Beyond that, you are probably covering the same need twice since whatever expense you throw in there would otherwise probably have been paid by the income you already replaced. Term life for a younger healthier person is very affordable because the company is counting on you outliving the term. Upon expiration, it becomes much more expensive because you are 10, 20 maybe 30 years older. Whole life doesn’t expire. As long as you keep up on the level premium, someone will hand your spouse, children or whoever your beneficiary is the money they need to replace the financial loss.

    Thank you.

  2. Hi Pinyo,
    I wish everyone in the market for life insurance was as analytical as you. In a perfect world, everyone should consider all the factors your agent went over with you to come to the amount you need. I’m an agent as well, and I’ll tell you that you are among the few who would take the time and energy to fill out his worksheet. 90% of the life insurance I sell is simply using an income replacement model. No one gets rich here… just leaves enough to have his/her income replaced for x amount of years, with a few additional factors such as inflation and interest.

    I don’t follow your agent’s approach because it’s not best for my prospects. Let’s be clear. What’s best for my prospect is that they buy life insurance, even if the face value is not calculated using an in depth worksheet. If the worksheet is too much for them, then it’s not the right thing for them, because they’re gonna walk away without insurance. Anyway, for your visitors who might want a simpler approach to buying life insurance, I’ve written an article recently titled “How Much Life Insurance do I need to Cover my Mortgage“.

  3. WealthBoy says:

    As far as whole life goes, yeah it’s not a very good product. You’d do much better to just buy term and invest the rest yourself. It gives you much more control over the investment options, and ultimately a much better ROI if you’re investing for the long term.

  4. Jerry says:

    The insurance agent made a great point about your life insurance being linked to your job, in the event that you lose your employment – but isn’t that the same problem with job-linked health insurance? For some, that may be a selling point for nationalized coverage… I’m not completely convinced that it’s the answer, but that is certainly an argument.

  5. plonkee says:

    I’m not sure that you should ignore your job-based life insurance policy – just be aware that if you changed your job you’d have to replace it. But then, I speak as a single person who is approximately‚ £90k ($180k) over-insured through work alone. If I die, my beneficiaries are going to be absurdly wealthy.

    Thanks for the mention by the way.

  6. Jonathan says:

    Pinyo you make some excellent points here. It’s important to have enough to cover to take care of the essential elements and these can only be calculated by a clear budget. Medical insurance is one of the biggest aspects to get covered.

  7. Pinyo says:

    @My Dollar Plan – Thank you for pointing out Social Security. I will have to do some research to find out how that works.

    @Steve – Certainly sobering. Regarding medical insurance, it seems that employer provided insurance is still the best value. I have done some searches in the past and couldn’t find anything that could be my employer’s.

  8. Erik says:

    whole life insurance is a horrible product. I’m glad the agent was honest with you.

  9. Steve says:

    Thanks for the mention. It’s an amazingly sobering exercise when you start considering what your family would need to “replace” your income-generation ability, isn’t it? I didn’t enjoy the process much but I’m glad I did it – I sleep easier knowing that my wife and kids will be provided for if anything happens to me. And I think one point you made bears stressing heavily: don’t get life insurance through your job. I relied on a job-based life insurance policy before we had our first child, and I suddenly realized when I quit that job and went into consulting that I had no life insurance. It was not a pleasant realization – similar to having employer health care benefits which can be snatched away with a second’s notice, but at least for that you have COBRA. No such animal for life insurance, though.

    Steve

  10. Pinyo says:

    @Mike – No problem.

    @Becky – Thank you for that information! That could be a post in itself :-) Looks like the best option is for her to roll it over into IRA. I will have to do more research on this.

    Regarding whole life recommendation, I assume the only motivation is better commission.

    @Adfecto – Yeah, it’s worth the wait IF you can get in shape; otherwise, it will just get more expensive each year. As far as how much to buy, there’s two ways to think of it: buy enough to cover them for a few years and pay for important expenses (e.g., education, mortgage, etc.) OR buy about 20-25 so that it completely replaces your income as long as your spouse invest the sum properly.

  11. Don’t forget that your son would likely get some money from Social Security if one of you dies. I didn’t see that accounted for. And I’m surprised the agent had you ignore your retirement accounts. Insurance is to make you whole again, not profit. If you ignore some of your money you will be overbuying.

  12. Becky says:

    Also, I’m curious what your agent’s reasons were for any type/amount of whole life policy. I’ve always planned on doing JUST term life once my hubby and I have kids.

  13. Becky says:

    Your 401(k) and IRA would go into your wife’s name if she is your beneficiary. She would be able to roll the 401(k) into the IRA (highly recommended). There are a bunch of different options for her. I don’t totally understand them, but basically it looks like she’ll have to start taking distributions in some form or another:

    1) Total distribution (taxable in year distributed)

    2) Account must be depleted within 5 years of the year following death.

    3) Takeover: IRA becomes IRA of the spouse. If spouse is under 59 1/2 and needs penalty free income for a number of years before reaching 59 1/2, the RMD over the recalculated SLE (single life expectancy) of beneficiary can often be suitable.

    4) Take an RMD over the recalculated SLE of beneficiary, beginning by (a)when account owner would have been 70 1/2 or (b)December 31 of the year after death

    These options are providing you would die before age 70 1/2. Rules are a little different once you’ve reached that age because of RMD (required minimum distribution) rules.

    I don’t know if that helps or not, but I thought I’d post what I found :)

  14. Adfecto says:

    I need to get off my bum and re-evaluate my insurance needs too. Thanks for the reminder. I’ve got about $250k in coverage through work but I know I need about double that to be sure my wife is taken care of for a good long while. I keep putting it off because I know I won’t get the ‘elite’ pricing (due to weight) so I’m hoping a few months of going to the gym will get me there (which I’ve been doing regularly since January). When we start having kids that amount will need to go up dramatically too.

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