Just while coming back from work, I heard on NPR radio that John Hancock is offering up to 15% of discount on life insurance if you wear a Fitbit and let them track your daily exercise routine. More you exercise, run, walk more discount you’ll earn. This news also appeared on CNN. As per the NPR report, life insurance acceptance is at the same level it was in 1970’s, although population grew by 20% since that. So is life insurance not that necessity anymore?
Let’s explore some essential aspects of life insurance and try to gauge if life insurance is the financial asset you need. As I explained before, insurance is a defense against any misfortune. Misfortune to you, your family or your resources. I view investment as an offense to secure your financial future while insurance plays the defensive part. There’s no doubt that to win you need a strong offense as well as defense.
Let’s explore the elements of life insurance.
What is life insurance?
Life insurance actually is a misnomer. It’s actually a death insurance, but they can’t call it that. You pay one time or regular premiums to ensure your family gets some money if and when you die. The more you want your family to receive, more premium you’ll have to pay.
Why is it needed?
As I said, a life insurance actually ensures your family from your death. The emotional trauma can’t be cured, but the financial trauma can be cured up to the full extent, by means of a large life insurance. This is almost must have if you’re the only breadwinner for your family. Else, the loss of income can’t be compensated.
Do I need a life insurance?
Basically, everyone who loves their family and doesn’t have sufficient saving or extra family income, other than our income. I have one and as far as I know, I haven’t come across any that don’t have a life insurance. Most have through their employers, though.
If you have a little child(ren), you should have a life insurance to cover for their growing up and education, even if your spouse earns. That’s the hard rule. If your family requires you to continue to work and earn, there’s a need for your life insurance. That’s how I see it!
You may not need a life insurance when there’s no one in this world who depends on your income.
What are my life insurance options?
There are several types of life insurance options, but there are basically two categories of life insurance: term and cash value.
Term life insurance
This is the lowest cost life insurance available in the market, in terms of premium amount. This policy has a fixed validity. After which your life is not covered by that policy. Example – You insure yourself for a sum of money, say $500,000 for 20 years. By insurance company’s calculation, you may pay an amount upfront or you can pay it in installment. generally, the premiums of this policy are so low that you can pay the amount up front or in a few installments.
Why are term insurance premiums so low? Because if you remain alive for the term (20 years in our example) then you or your family gets nothing. The insurance company keeps your premium amount.
Quite naturally, term insurance premium increases by the age. So for $500,000/20 years policy, a 30 something would pay a lot less than a 50-year-old.
This is insane, quite honestly, to me. Once I had that in India, where I came from. I got rid of the policy and I am glad I did. Insurance companies always claim this as an investment substitute. You buy a policy at a face value say $500,000. You continue to pay a recurring premium, every month. Your money gets used by the insurance company to generate income for them, much the same way as banks do. Here also, you’ll have a fixed term of insurance validity.
If you die, within the term, your family gets $500,000. If you don’t die you’ll get back the money you accumulated, with your portion of the income it generated.
If you compare with another mode of investment, like index funds, ETFs, the rate of return from a cash value insurance policy is abysmally low. So, I don’t think anybody can consider this as an investment alternative. If you can pay a certain amount every month. I’d suggest you get a term policy and invest the monthly amount in stocks/funds.
Per Investopedia “A type of flexible permanent life insurance offering the low-cost protection of term life insurance as well as a savings element (like whole life insurance) which is invested to provide a cash value buildup. The death benefit, savings element and premiums can be reviewed and altered as a policyholder’s circumstances change. In addition, unlike whole life insurance, universal life insurance allows the policyholder to use the interest from his or her accumulated savings to help pay premiums.”
For more you can refer to Wikipedia.
How much life insurance do you need?
Let’s first start by answering a question.
How much you need to earn till your spouse is alive and children are not on their own?
So, I think you got where I am going with this “how much” question. You need that much amount in your absence that you would have earned being alive. Now the most difficult part. How to calculate how much you need to earn to sustain your family till they need.
1. First, check and tally all debts you have. Your car loan, student loan, mortgage, credit card debt. Add them add. Keep this value aside.
2. Will your family incur any major expenses, like higher education cost, or any pending litigation charges, buying a new car in few years, etc? If there are such future expenses you could foresee, add them us and keep the value aside.
3. How much do you spend every month? Let’s multiply this number by 12. This will give you yearly spend. Add some buffer, if you like (many of us like to go on a yearly travel) Let’s say you spend on average $30,000 every year. Now multiply it by 20. So the value would be $600,000
Now add 1,2 and 3 to come to an estimated amount of life insurance you’ll most likely need.
Where to buy a life insurance policy?
I am insured through my employer provided group life insurance plan. I have the amount as 8 times my annual gross salary. I think this amount is quite sufficient for my wife to survive if I am gone one day, we do not have a child either.
Many of my readers would probably have employer-provided life insurance. But there is some limitation to it. The premium gets deducted from your paycheck, and in most cases you’d end up paying more premium than you would have paid had you gone solo.
If you’re young, nonsmoker, I’d suggest you go for individual life insurance from outside. Also, when you retire or switch jobs you’ll be as good as without an insurance.
Readers, do you have a life insurance policy, if yes how did you come to the insured amount figure? And how did you chose the policy?