Making Progress Toward Buying Our Life Insurance

By , on June 13, 2008

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).

Calculate How Much Insurance I Should Have

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.

Paid Off Amount

First, there are three things I would like to be paid off upfront if something happened to either one of us:

1. Final Expenses ~\$15,000
2. Debt ~\$20,000
3. Mortgage ~\$135,000

Adding these up, they come out to be \$170,000.

Living Expenses

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

Total Coverage

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.

Variables That Affects The Coverage

From the example above, there are several key variables that affect the coverage amount.

1. Paid off amount — For us it’s \$170,000 for debt, mortgage, and final expenses. This will be different from person to person.
2. Expenses – I kept the expenses fairly high so that my wife wouldn’t have to change her lifestyle drastically. On the other hand, I didn’t factor in the expenses of a second child or inflation either. For example, if our monthly expenses were \$1,000 lower, my wife would only need \$640,000 instead of \$960,000.
3. Income — The calculation above also assumed that my wife income is staying at the same level, however, this is probably not going to be the case. For example, my wife is currently working part-time. If she’s the only earner, she’ll most likely go back to work full-time and double her income.
4. Return on investment — 5% is a fair number. This amount should be adjusted down if the living spouse is risk-advert, or not savvy about investing. Likewise, the amount could be adjusted upward — however, I wouldn’t push the amount above 7%. For example, at 7% return on investment, my wife would only need \$686,000 instead of \$960,000.
5. Taxes — 25% is a fair number. However this could be adjusted up or down depending on the income level. For example, at 20% tax rate, my wife would only need \$900,000 instead of \$960,000.

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.

Opportunity Cost

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:

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Pinyo is the owner of Moolanomy Personal Finance and an entrepreneur with over 20 years of business experience. He has a strong appreciation for business management, investing, and wealth building. He has written for many online publications, including American Express and U.S. News.

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1. Nicole says:

You are smart to be looking into this so completely. My dad died suddenly at the age of 51 a few months ago. The insurance money from his death has given me peace of mind to not worry about my mom being able to afford to stay in her house… You are doing a great thing.

2. The Happy Rock says:

Pinyo,

Off the top of my head \$100 a month seems high. I would expect about closer to \$70 a month if I expected 1.25 million coverage for me, a 30 year old male, on a preferred 30 year term policy. I don’t know if we exactly match up health and age wise, so I can’t account for all the variables.

You can see if the company that you here advertised all over Dave Ramsey might give a different comparison. Even if you aren’t a huge fan of his.

3. My Dollar Plan says:

Wow, the \$100 seems high to me too. Ours is less than \$45 per month for an equivalent amount. Two very healthy adults, age 29 and 31. Although we have much less because our assets will cover most of the expenses.

4. Pinyo says:

@The Happy Rock — I think it’s a little high too, but after so many quotes, that seems to be the best I could do — at least with tier 1 insurance companies. Also, it’s 2 policies — \$1 mil for me and \$250k for my wife.

5. Jonathan says:

great idea to break down your financial circumstances and base your decision on that. It’s amazing how many people just pluck a figure out of nowhere

6. Rob says:

It is good that you are thinking through this carefully. And it is important not to rely only on life insurance through work.

I am a broker and have an obvious bias in the following – working with a broker is a very good idea. This is because a broker can guide you through the process. THis includes the medical requirements, discussing pre-existing conditions, your lifestyle, your occupation and recomending which company will treat all of your unique circumstances the best. It doesn’t cost you more to use a broker so why not get an experienced professional working with you?

I am working on an informative insurance site and have a page on the various types of life insurance and the three different ways to buy insurance (direct, through an agent, or through a broker): Canada Life Insurance

7. Michael says:

If you fall into the super preferred rate class, then your premium seems a little high to me as well given what I paid for my term coverage.

You are also right to ignore your employer provided life insurance in your plan. You don’t want your carefully thought out post death plan to be thwarted because you were unemployed or moved to another job that didn’t have the same life insurance benefits. It’s sad but I see so many times in the life insurance industry how many people rely on employer life insurance as their only coverage only to find that they can’t get affordable life insurance down the road due to declines in their health.

8. MITBeta says:

After doing a lot of looking, we bought our insurance through SBLI. I have a \$1.1M policy and my wife has a \$300k policy and we pay about \$100/month for that. It looks to me like you’re on par.

9. Denise says:

I have to say I am impressed with your thoroughness and foresight. It is heartening to see someone who is thinking of all possible variables in order to protect his family against future crisis. You have mentioned that you have already received a few quotes from the Internet. I would say, get a few more as well to truly make a comparison. The service providers available online are THE only place where you will get a truly unbiased opinion. Most brokers are attached to some life insurance companies – that is just the way the business functions. So, check out some more quotes to be doubly sure.

Denise at AccuQuote
Disclaimer: I work for AccuQuote and this is my personal opinion.

10. Sallie Lee says:

hello, ive been with sunlife insurance plan..and its the best thing ive ever had..and my husband too..if you like to know more about it

theyre having the FREE, no obligation quotes on LIfe insurance now..

email me at sallie.1217[at]yahoo.com

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