Ughhhh. Life insurance isn’t exactly a fun topic to talk about, is it? Yet, it is essential coverage for many families who want to protect the future earnings of one or both spouses.
There used to be a rule of thumb among insurance agents that your death benefit should be equal to a multiple of seven to 10 times your annual pre-tax income. Here are a three scenarios where this rule of thumb is not helpful:
1. Stay-At-Home Parents
If you’re a stay-at-home parent, you’re not receiving financial compensation for hard work at home. Following the rule of thumb, you should have no life insurance coverage, because your financial earnings are zero. However, your spouse would need to secure childcare and may require other professional services if you unexpectedly die. Examples of these services include housekeeping, laundry, meal delivery or prep services and home maintenance.
From just $107.88 $24.99 for Kiplinger Personal Finance
Be a smarter, better informed investor.
Sign up for Kiplinger’s Free Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
Consider the total cost to provide all these services on an annual basis, and multiply by the number of years that your children will require additional financial support. A stay-at-home parent with two toddlers will require more life insurance than a parent with two teenagers who will be out of the house in a few years.
2. Families With Young Kids
Budgeting as a young family is tough. You are steadily building work experience and have the added expenses of childcare and schooling. You may need MORE than 10 times your salary. Think about future expenses and how long it will take you to amass enough wealth to accommodate your family’s needs.
I’ll use my family as an example. We have a mortgage, and our three boys are ages 3, 5 and 8. Full-time childcare costs for our younger boys average $20,000 annually, and private grade school tuition for our eldest son runs $5,000 annually (excluding after-care program costs). We plan to send all three boys to Catholic high school, which runs about $15,000 annually per child. That figure is not even factoring in the costs of clothes, activities and food for our growing boys. College is incredibly expensive and must be considered as well.
After carefully reviewing these expenses and our future earnings, we decided that 10 times annual salary isn’t nearly enough to fund our family’s lifestyle. My husband and I each have coverage closer to 20 times annual salary.
3. Those Nearing Retirement
For term life insurance, especially, age is not on your side. Premiums increase substantially in your 50s and 60s. Perhaps you’re within a few years of retirement and you’ve amassed enough wealth to live comfortably. Self-insuring, or using existing assets in lieu of an outside insurance policy, may make sense.
According to the Merriam-Webster, insurance is “a means of guaranteeing protection or safety.”
In other words, when you purchase an insurance policy, you’re transferring risk from yourself to an outside third party. In exchange for that transfer of risk, you agree to pay premiums. When you stop paying premiums on a term life insurance policy or disability policy, your insurance coverage ends. Whole life or variable life policies usually require significant premium payments in the early years of a policy with the hope that premiums can stop in later years and the policy remains active or “in force.”
A Look at the Different Insurance Options
Now that you have a framework for the amount of life insurance coverage you may need, let’s turn to the types of insurance policies.
Term Insurance
For young families, especially, term life insurance is my typical recommendation. It is the most inexpensive type of policy and akin to renting versus buying a home. You only have coverage if you continue to pay the premiums. Some term life policies have an increasing premium, because they assume your earnings will steadily increase. Other term policies are fixed: Your premium will remain the same each year for the duration of the policy. Under the fixed-policy, premiums are higher if you have a longer term. For instance, your annual premium may be $1,000 for a 15-year level term but $1,300 for a 20-year level term.
Large employers typically over basic life insurance coverage equal to one times your annual salary at no cost to you. They also may offer supplemental group policies (i.e., up to a $500,000 death benefit). The supplemental group policies vary significantly by employer.
One of my clients is a federal agent. She was paying over $500 annually for $500,000 of coverage as a government employee. We looked at individual term quotes and found a policy with a lower premium (about $450) for $1 million of coverage. She could get double the coverage for less cost by using an outside, individual policy! Her employer penalized young, healthy employees in their group life insurance policy. If she were 20 years older, her employer-provided group policy may have been the better deal.
Whole Life
Compared to term insurance, whole life policies offer valuable long-term protection. When the whole-life policy is “paid up,” you are no longer required to make premium payments. In the meantime, cash value builds in the policy. You can take loans against the cash value, but be wary of high interest rates.
Here’s another personal example. I started working with very wealthy families in 2006 and found myself collaborating with insurance agents on whole life policies for select clients. Many of these families were using life insurance to pass more wealth to heirs — income tax free.
I became engrossed in this world of estate planning and tax mitigation and pursued a whole life policy for myself. My annual premium was $3,000 for $500,000 of death benefit. Much of the premium in the early years paid the agent commission and internal costs. Couple that with mediocre dividends from the low interest rate environment, and I was left with very little cash value.
About 10 years after starting this policy, I decided it was not worthwhile anymore. My accumulated premium payments were slightly more than the cash value of the policy. I could take the policy “paid up” and reduce the death benefit to about $130,000; alternatively, I could remove the cash value. I choose the latter. Paying off my car loan and purchasing a new $1 million term life policy ($450 annual premium) provided better bang for the buck.
As you can see, insurance isn’t cut and dried. Choosing an appropriate insurance policy can be difficult on your own. A Certified Financial Planner™ who specializes in comprehensive financial planning can help you evaluate and secure the life insurance policy best suited to your needs. Even better, consider working with a fiduciary fee-only planner who doesn’t work on commission.
-
How Prepaid Verizon Phone Service Works and When It's a Smart ChoiceExplore the differences between Verizon Prepaid and Verizon Postpaid plans—costs, perks, flexibility, and when going prepaid makes sense.
-
Try This One-Minute Test to Uncover Hidden Health RisksFinding out this little-known fact about your body could reveal your risk of heart disease and more. It's a simple, free check for healthy aging.
-
Social Security Wisdom From a Financial Adviser Receiving Benefits HimselfYou don't know what you don't know, and with Social Security, that can be a costly problem for retirees — one that can last a lifetime.
-
Take It From a Tax Expert: The True Measure of Your Retirement Readiness Isn't the Size of Your Nest EggA sizable nest egg is a good start, but your plan should include two to five years of basic expenses in conservative, liquid accounts as a buffer against market volatility, inflation and taxes.
-
New Opportunity Zone Rules Triple Tax Benefits for Rural Investments: Here's Your 2027 StrategyNew IRS guidance just reshaped the opportunity zone landscape for 2027. Here's what high-net-worth investors need to know about the enhanced rural benefits.
-
The OBBB Ushers in a New Era of Energy Investing: What You Need to Know About Tax Breaks and MoreThe new tax law has changed the energy investing landscape with expanded incentives and permanent tax benefits for oil and gas production.
-
Ten Ways Family Offices Can Build Resilience in a Volatile WorldFamily offices are shifting their global investment priorities and goals in the face of uncertainty, volatile markets and the influence of younger generations.
-
Should Your Brokerage Firm Be Your Bookie? A Financial Professional Weighs InSome brokerage firms are promoting 'event contracts,' which are essentially yes-or-no wagers, blurring the lines between investing and gambling.
-
Supermarkets Have Become a Pickpockets' Paradise: How to Avoid Falling VictimSome stores regularly rearrange inventory with the aim of increasing purchases, and they're creating opportunities for thieves to steal from customers.
-
I'm a Wealth Adviser: These Are the Pros and Cons of Alternative Investments in Workplace Retirement AccountsWhile alternatives offer diversification and higher potential returns, including them in your workplace retirement plan would require careful consideration.
