How to Approach Term Life Insurance

Term Life Insurance 

If you are a parent, you need life insurance. What type of life insurance should you buy? The simple answer is term life insurance in most situations. It is the cheapest insurance you can buy with the biggest benefit. Unfortunately, 70% of life insurance policies sold are cash value life insurance. This is insurance that provides a death benefit, meaning you get cash when you die. It also accumulates a cash value that you can borrow against or redeem before you die. Today we will discuss how to approach term life insurance.

An Example

You decide to compare a term policy and a whole life policy for $250,000 (This amount isn’t going to be enough for a high income earner, but it’s just an example). The term policy is $21 a month. The Whole life is $286.66 a month.  You can see the comparison here.

You may ask:

Where does the $265.66 go?

That extra money goes to the cash value and will be “invested”. The problem is the investment the insurance company makes for you will be a heck of a lot more expensive than what you could do for yourself.  This is how high expense investments turn out.

approach term life insurance

And that is just with a 0.6% difference in expenses. Insurance companies are WAY worse. (From Vanguard)

 

Don’t Combine Insurance and Investing

As a general rule, combining investing and insurance is a bad deal. If we follow the advice that those who keep investing expenses low get the best results, cash value life insurance is one of the most expensive investment options out there.

This article will focus on term life insurance. It is purely an insurance product. You determine a value payable on death, and there is no accumulation of value during the payment of the premiums. The assumptions for the purposes here are that you are a high income parent as usual.

So now that you know you need term life insurance, how do you go about getting that insurance?

I recommend you go to an online broker and get a quote from several different companies. You can even go to different brokers. Some examples are Selectquote and Policy Genius. I personally went through Selectquote for my policy. Banner Life ended up being my best option but they will vary depending on location, age, and health status. The sent a nurse to my house to do the insurance physical and I had my policy within a couple of weeks.

 

First Question: Should you get life insurance?

 

Answer:  Probably

 

Unless you are financially independent right now, you need life insurance. You have a high income and are a parent. You might have a nonworking spouse. What are they going to do if you suddenly become room temperature?

So we have established the fact that you probably need life insurance. The next question is how much should you get and for how long?

Well, that depends on your goals. Here are some questions to ask:

  1. Do you have debt?
  2. What are your monthly expenses?
  3. What are your goals for your family if you are not there?
  4. Are there other expenses because you died?
  5. Do expenses disappear because you died?
  6. Have you talked with your spouse about the plan to use this life insurance?

 

Let’s Tackle These One at a Time:

 

Do you have debt?

Some debt will go away when you die. If you have federal student loans, those are canceled when you pass away. Other private student loans have different stipulations. Some have the capability to be discharged after death but require a death certificate (I guess they don’t just take your word for it). If you have a cosigner on the loan, he/she will be responsible for the balance. Your parents can be liable for the balance if they cosigned for you.

If your spouse co-signed she/he can be liable. Community property states hold your spouse liable for private student loans if the loans were taken out during the marriage. If you have private student loans with a cosigner, look into cosigner release. This usually requires you to have made on-time payments over a certain time frame.   Some loans are triggered “auto-default” when either the borrower or cosigner die and this can be a big burden during an already difficult time.

Car Loans

approach term life insurance

That’s gonna be a big car loan!

Other debts will go away when you pass. This is a contingent that you don’t have a cosigner on the debts. If you do, the cosigner becomes liable and some loans are due immediately after death. That is something to think about when your loved one is already having to make funeral arrangement and deal with your passing.

If you have a car loan, the lender can repossess the car but you likely won’t need the extra car anyway and it could be sold.

 

Credit Cards

approach term life insurance

Cash or Charge?

Concerning credit cards, the lender can come after the estate funds, but the beneficiary of your term policy is not liable for your credit card debt. As long as the beneficiary is not a cosigner/joint account holder on the credit card, they are not responsible personally. An authorized user is not liable for the debt, an important distinction.

If you are in a community property state, like I am in Texas, your spouse is liable for the balance. This is important when thinking about the amount of term life insurance you should buy.

 

What about my mortgage?

approach term life insurance

Nice House!

There are federal laws that allow a mortgage transfer to an heir. The mortgage isn’t due in full at the time of your death like some other loans. Since your family probably need a place to live, they can keep paying the mortgage and work on getting it transferred in your heir’s name after death.

As long as you don’t name your estate as beneficiary with your life insurance policy, your heirs do not have to use the term life insurance funds to pay down debts that are part of your estate. Now if the heirs are cosigners, or a spouse in a community property state, they will still be liable for the debts as described above, but the insurance company doesn’t have to pay those directly.

What are your monthly expenses?

Without you there, will there be fewer expenses?

This is unlikely. There will probably be more. Suddenly, you have a single parent household. If you are a single parent, you have a no parent household. Some estimates have been made that a stay at home spouse fulfills the role of $121,000 a year in expenses. Those expenses will have to be delegated.

Whether it is home maintenance, child care, meal preparation, medical, taxi, financial or legal services the non working spouse provides, those expenses add up and should be noted.

What are your family goals?

Are your kids young? Are their private school expenses coming up? What about college expenses? Do you want to pay for weddings? The immediate expenses if you die are important, but you should also think about the expenses to come. You should be able to account for future expenses too.

 

What other expenses?

Now that you are gone, what other expenses will the family need to pay? Number one is the funeral. That averages between $7000 and $10000 dollars. You can self insure for a cost like this, but that reduces your estate. Do you have specialized skills that your spouse would have to learn or hire out? Did you do the taxes or clean the pool? Did you care for the lawn or make all the meals? Anything you did, will be delegated.

 

What expenses will disappear?

approach term life insurance

What disappeared?

Dying will save some expenses as well. If you have a commute, all the job related expenses disappear. There will
be less food, less travel/transportation, and clothing costs. Calculating what percent of the budget is solely due to your costs will be helpful in calculating the amount of term insurance to purchase.

 

 

What’s the plan? 

The most important thing you can do is get on the same page with your spouse and even older children. I know that death is a subject avoided like the plague. You should sit down and talk about what the plan is when one of you passes on. Talk about what to do with the house, the cars, the kids’ care and educations. Figure out the funeral arrangements and where you want to be buried. Get a Will! Identify the areas your spouse has no idea about. Get a folder or legal pad and write all accounts and assets down or use a tool like Mint.com or PersonalCapital.com to categorize everything at your fingertips.

So how much term insurance should you get?

There are several rules of thumb out there. You could approach your insurance like you would a retirement account and try to achieve 25 times your yearly expenses.

You could just multiply your income times 10. (Not sure what that achieves except to keep you on your feet for at least 10 years).

Another options is to add up all your debts. Then multiple the amount of income for the number of years you need it and add that to the debts. Then subtract your assets. that is how much insurance you should buy.

I’m partial to either getting 25 times your expenses or multiplying your income by the number of years needed with the debts and subtracting the assets. These make the most sense to me.

 

Example Time

Lets look at an example. See Mr. And Mrs. Hip below. Mrs. Hip is an attorney and makes $200,000 a year. Mr. Hip stays home with the kids, Bobby age 2, and Sally age 3. Mr. Hip has a side hustle Etsy shop selling some home-made natural soaps. He makes $15,000 a year. They have a $400,000 mortgage and $35,000 in auto loans and credit card debt. They also want to put away $100,000 per child for college.

The have some assets totaling $79,000 currently. See the below table for how much insurance they would need for each calculation method.

As you can see, the amounts calculated can come out quite different.  Only you can decide what is right for your family based on your risk tolerance, willingness to reduce expenses, if you don’t have enough insurance and savings rate.

Now What?

The next decision is to figure out how many years you need the insurance. Usually you would take it until the kids are out of school and/or your retirement account is large enough to cover your expenses without the insurance. If the youngest child is 2, then a 20 year term is a good timeline if you plan to be financially independent by the time the child leaves the house.

You could also buy a decreasing term that pays a smaller and smaller amount each year. The theory behind this is you will save enough to cover expenses for retirement and eventually not require the insurance. The premiums are generally cheaper because you aren’t truly buying as much insurance for as long a time.

If you have a retirement plan (and you should!) then you could buy a term long enough to cover to that point. You could keep the insurance until the kids are no longer dependent on you, but if you don’t have any assets at that time, your spouse could still be financially devastated.

Conclusion

So now you have the tools to get the right insurance to cover your family in the event of your untimely demise. Figure out what method you want to use. I recommend the yearly expense method and multiplying by 25 to get the amount you should buy if Mrs. Hip died. You should probably add some college costs for each child but remember to let the kids have some skin in the game.

For the couple above, with Mrs. Hip dying, that would be $2,7000,000 if college costs were $200,000. Then Mr. Hip could withdraw 4% a year and live on it indefinitely, especially if he were to expand his Etsy business or get another job.

If Mr. Hip died, Mrs. Hip would finance the kid’s school and childcare until she either gets remarried or doesn’t need to care for the kids any longer.

The point is to talk about the plan if one of you die prematurely.  So have you bought term insurance? What method did you use? Do you have any other questions about term life insurance?

how to approach term life insurance

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Tom
Tom is a doctor, husband and father of five with a passion for parenting and finance. When he isn't skateboarding, riding BMX, or jumping on the trampoline with his kids, he is reading and writing about personal finance. He helps high income parents educate and mentor their kids to become financially, emotionally, and intellectually self sufficient.

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