Do you need life insurance?

Author: Gagan

SHORT ANSWER:

Buy a term life insurance policy worth 15x your gross annual income.

LONG ANSWER:

Easiest way to protect your family from a financial disaster is to get insurance coverage for low probability and high impact events.

Even though the chances of death are small, the adverse impact on family is just too big. If my family has to deal with the emotional trauma of my death or disablement, the least I can do is to make their financial future secure so they don’t have to deal with financial distress.

My wife and I had an honest discussion early on in our marriage about a possibility where I die or become disabled and hence not able to earn a living. As a single income household, we needed to protect our family if such an eventuality were to occur.

Here’s how we decided what type of life insurance to get and how much:

1. Multiply today’s yearly expenses (excluding mortgage) by 30 years and again by 1.04 to take care of inflation. Let’s say this number is $expenses.

2. Outstanding mortgage amount on our primary home. This amount is $mortgage.

3. College tuition for kids, adjusted for inflation. This amount is $college.

4. Amount of life insurance coverage provided by my employer (typically 2x to 4x annual base salary). This number is $employercoverage.

5. Amount of money in savings, brokerage, retirement etc accounts at the time. This amount is $savings.

We then did the simple math:

Coverage Needed = 2 x ($expenses + $mortgage + $college - $employercoverage - $savings)

Why 2x? This is called the factor of safety. Putting in a factor of safety takes care of any other things we might not have accounted for properly, such as: higher inflation, health emergencies, parents needing help, etc.

A couple other things we considered:

1. We also did research to make sure health insurance will be covered by the state Medicaid plan.

2. We assumed that social security payments would kick in after 30 years from that point.

3. We only bought term life insurance. Your insurance company or agent will try to sell you so many different policies, but all those policies make money for the insurance company and the agent, while increasing the cost for you quite a bit. Our goal was to buy peace of mind (a term life policy offers exactly that), not a financial investment. Term life policy is simple: You will get money only if you die or become disabled, else that money is gone.

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