A while ago, I met with an insurance sales agent and discussed life insurance coverage for my wife and I. Three months later and I am still looking — I am a little slow making these big financial decisions. Also, I am not rushing because I already have a $560,000 term life insurance policy through my employer. However, I am looking for two reasons: (1) I want an insurance policy that’s not dependent on my employment, and (2) I am still about $300,000 short based on my eFinPLAN report (see my eFinPLAN review).
I mentioned in the article above that I wasn’t satisfied with the calculation provided by my insurance agent. So I did some recalculations, which you can see below.
First, there are three things I would like to be paid off upfront if something happened to either one of us:
Adding these up, they come out to be $170,000.
To calculate living expenses, I tallied up our monthly expenses, which include: food, 529 savings for our son, day care, real estate tax, utilities, telephone, Internet access, cable, insurances, dental, medical, and miscellaneous. This sum matches up to what’s reported in Mint.com nicely.
Next, I compared our monthly expenses to each of our after tax income. As it turns out, I could cover the expenses with my income if my wife died, but my wife would be about $3,000 short each month if I died. In order to cover this shortfall, my wife would need investments that generate $3,000 per month, or $36,000 per year. With her investment skill, we believe she would be able to earn 5% annually. Lastly, we estimated that she’d be paying about 25% of that gain in taxes. Based on these three variables, I calculate the amount needed to generate $3,000 per month as follow:
amount needed x return on investment x (1 – taxes rate) = $36,000
amount needed x 5% x (1-25%) = $36,000
amount needed = $36,000 / 5% / 75%
amount needed = $960,000
Another approach is to follow the 4% safe withdrawal rate for retirees:
amount needed = $36,000 x 25
amount needed = $900,000
Based on the calculations above, the total coverage adds up to $1.13 million ($960,000 + $170,000). So our plan is to buy a $1 million term life insurance policy for me, and a $250,000 policy for my wife.
I was on the fence regarding 20-year term versus 30-year term, because (1) 20-year term is about two-third the cost of a 30-year term and (2) our finances could be drastically different in 20 years. However, after talking it over with my wife, I think we will go with the 30-year term.
From the example above, there are several key variables that affect the coverage amount.
As an example, assuming $2,000 expense, return on investment of 7%, and 20% tax rate, my wife would only need $430,000. As you can see, even small changes can greatly impact the calculation.
Following my own advice, I already got a few competitive quotes through InsureMe and NetQuote. One of the quotes came from a broker who is free to work with any insurance company. At this point, I think I’ll be working with him for the policies since he can run our information through several companies and find the best deal for us.
Based on the quotes I received we will be spending about $100 per month on the two 30-year term life policies. I recently did an article on opportunity cost, and our opportunity cost for these two policies over 30 years is approximately $121,000 — not bad for the coverage we are getting.
Other articles in this series: