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Determining our Life Insurance Needs I – Criteria


People generally don't like talking about death, especially planning for it.  I'm no exception, but with the new home and child coming, I'm looking into insurance more seriously.  Before, with both of us working and make comparable income, life insurance wasn't really a consideration because there weren't any financial dependents in the picture.  The only thing we had covered was the mortgage via mortgage life insurance.

With the new home, we're going with term life insurance instead of typical mortgage life insurance.  Why? The reason being is that mortgage life premiums stay the same with a decreasing benefit.  Term life benefits, however, do not change over the term.

Why not go with whole life or universal life?  To me, those products provide sub par investment return for the extra premium charged.  I'm planning on buying term life and investing the rest myself. 

Hopefully, by the time that the term insurance expires (20 years), we'll have a large enough portfolio to be self insured.  If not, we'll continue to buy just enough term insurance to cover our needs. 

If you want to read another opinion on term or permanent insurance, you can read Ed Rempel's article with this thoughts on universal life insurance.

So looking at the worst case scenarios, how much life insurance do we need?  Here are some of the factors to consider:

Assets

  • Existing life insurance
  • Household after tax income if one spouse were to pass
  • Portfolio value (rrsp, non-reg, cash)

Liabilities

  • Debt load if one spouse were to pass
  • Household/Childcare expenses if one spouse were to pass
  • Child's education fund
  • Child requirements if both parents pass
  • Funeral expenses

Tomorrow, I'll get into the actual numbers of our insurance requirements.  What factors do you consider for the amount of life insurance that you need? 

Photo credit: eh3k

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FT About the author: FT is the founder and editor of Million Dollar Journey (est. 2006). Through various financial strategies outlined on this site, he grew his net worth from $200,000 in 2006 to $1,000,000 by 2014. You can read more about him here.

{ 36 comments… add one }
  • The Financial Blogger February 26, 2008, 8:16 am

    Having a baby is changing priority, right FB?
    I remember that I became much more anxious about life insurance and the future of my children if I was to pass away at a young age.

    I think that when you manage your personal finance properly, there is no need for universal/whole life insurance. A T20 would be enough to cover your immediate needs. I guess that in 20yrs, you will probably be over your million net worth anyway ;-)

  • JRich February 26, 2008, 9:53 am

    I went through this last year. I determined that my life insurance needs over the next 5 years were drastically different than those for 15-20 years from now. Having 3 kids under age 5 and being the sole income for my family,I determined my need to be roughly $1mm in term insurance. Being 27 and in great health, I got a 10 year term policy at $180 per year (not a miss type). 20 year plans had an annual premium over twice that much.

    In 10 years, I will re-evaluate my need. I anticipate only needing $500k in insurance at that time based on the savings, home equity, etc. After 20 years, My 3rd child will be in college which will hopefully be paid for. My 401k and IRAs should have a total value over a million. At that point, I may determin that the $120k policy i get through my employer for free may be enough.

    An important considderation. There is a HUGE difference between big and small companies rates.

    Big Carrier (Ney York Life):
    I qualified for the best rate and they offered a $1mm policy for $780 a year.

    Medium Carrier:
    I talked to my car insurance guy (national company) and got qualified for a $450/year policy

    State Carrier
    Still a company thats been in business for 100 years but no adds and they had a crappy office, but came in at $180/year.

    One thing to point out with this is that they are all part of a national life insurance association and you are coverred if they go belly up. Not sure what its called but ts like FDIC for insurance.

    Also, agents will give you a wide range of answers as to how much insurance you need. Ney York Life Actually thought I only needed $400k or $500k but I think that had something to do with the fact that I cringed at the rates.

    And, they make MUCH more money off whole life plans, so they are going to push those big time. Don’t listen. Its a horribly bad investment for 99% of people.

  • George February 26, 2008, 10:17 am

    FT, if you still have the mortgage life insurance, I suggest canceling it and increasing your term coverage commensurately. CBC’s MarketPlace did a story a week or two ago about bank-issued insurance policies, and it turns out that they often aren’t worth a penny – since the bank and insurer doesn’t do any underwriting (medical checks etc) before issuing the policy, they check for problems only after you make a claim. In the case of the two people profiled on the story (who had recently lost their husbands) the claims were denied and the premiums refunded. Of course, the widows were still stuck with the mortgage…

    We signed up for a term-10 joint-first-to-die policy last year, and the cost was about $400 per year for $400k of coverage. Our only debt at the moment is our mortgage, and within ten years we anticipate that it’ll be gone, so our coverage requirements will drop then as well.

    One word of caution when determining “income replacement” values – it makes no sense to look at gross salary when calculating how much life insurance is needed. Instead, look at net salary and make an adjustment for any work-related benefits (medical/dental) that would be lost if one spouse died.

  • Canadian Capitalist February 26, 2008, 11:33 am

    FT: With a baby on the way, you definitely need insurance. As much as dollars and cents, insurance is also about peace of mind, so I’d be very conservative with assumptions of how much is needed. Term is so cheap that it’s better to be safe than sorry.

  • squawkfox February 26, 2008, 11:34 am

    George: I too saw that episode of CBC Marketplace, such a sad story but very eye-opening. My hubbie and I have term-life, thankfully.

  • Dividendgrowth February 26, 2008, 12:27 pm

    With life expectancy increasing in the western world, wouldn’t a good “insurance policy” be investing in life insurers companies?

  • Michael James February 26, 2008, 12:55 pm

    Are you sure that you actually have mortgage life insurance? Back in the 90’s I paid for mortgage life insurance with my bank until I found out that I may not actually have been covered.

    As I found out later, the insurance company underwriting the mortgage insurance offered by the bank did not check whether I qualified for the insurance until after a claim was made. If I had died, they would then have spent the money to check my application. If I qualified, then they would pay off the mortgage. If I didn’t qualify, then they would just give back the payments. It’s not too hard to figure out that the insurance company could help themselves by being very picky about who qualified after the fact.

    I don’t know how common this is now, but unless you’re certain that you are actually covered, it might be smarter and safer to get life insurance separately that is intended to pay off the mortgage.

  • Miso February 26, 2008, 3:52 pm

    Am I paying too much for my term life insurance? Mine is $85/month for 30 years, covers 300k for each me and my spouse (so 600k if we both pass). We are under 30 and qualified for the best rate.

  • JRich February 26, 2008, 4:53 pm

    Miso,

    That may not be bad. Its hard to say becasue you are getting the insurance for 30 years. But do you really need this level of insurance? I would imagine that your need will greatly decrease over those 30 years.

    Say you are 25. When you are 54 years old, will you still need $300k of insurance. Probably not. Probably $0.

    You probably should have gotten a 20 year term and saveda bunch of money or got a 10 year and reassessed you need at that time.

  • Nate February 26, 2008, 7:23 pm

    Hey FT, can you share your thoughts on the TFSA (Tax free savings account, announced in the new budget) with us tomorrow?

  • DJ February 26, 2008, 8:26 pm

    In the insurance biz, we used to have to learn a formula (acronym technically) to justify the amount of insurance a client is purchasing, because technically you aren’t supposed to be picking random coverage amounts (“gee, I think I want to insure myself for 2 million dollars”), you have to be able to justify it.

    The formula is MEDSEL:
    Mortgage Expenses (to pay off mortgage)
    Education Expenses (for children/dependants)
    Dependants (pay for kids expenses)
    Spouse’s Income (enough income for your spouse to take time off work to raise kids, grieve, etc.)
    Emergency Expenses (a small/medium emergency fund for your family)
    Last Expenses (basically, funeral and estate expenses)

    There ya go, don’t know if that’s helpful at all but that’s still what I would use if I was still licensed and selling (I still work in the biz part time but I’m about to finish my undergrad degree in a completely unrelated area)

  • DAvid February 26, 2008, 9:15 pm

    Nate asks: “Hey FT, can you share your thoughts on the TFSA (Tax free savings account, announced in the new budget) with us tomorrow?”

    You could go to Canadian Capitalist today!

    DAvid

  • Ramis February 27, 2008, 1:35 am

    I always come across people who have a huge amount of term insurance, makes sense because they believe that is wat they need. And usually insurance sales reps will recommend those huge amounts, because they make more on it. HOWEVER I provide my clients with a combination of term and some permanent. When it comes to protecting your mortgage i usually recommend a combination of T10 and T20 (depending on the situation). The reason being that although your mortgage is 300K (just an example) you will have paid down part of that in about 10 years, in 300K let’s say about 100K of your principle because of high initial interest payments. So after 10 years you only have a need for 200K. So in this case you could do a combination of T10 100K and T20 200K.

    For the above example T20 for 300K would cost about $53 for a Male 35 and female 33 non-smoker.

    A combo would cost about $48 for the first 10 years and $43 for the last 10 years. Although the difference here is small amount $5 initially, the savings increase with higher face amounts and other expenses added.

    For my clients i usually recommend Family guaranteed income coverage.

  • Doug Ransom February 27, 2008, 10:13 am

    A common approach to determining life needs is, rather than consider your assets and liabilities, to consider your human capital. If you make $50,000 a year after tax, you would want to replace most of that until your planned retirement date taking into account inflation. Discount that to the present with your return rate assumptions. Many people are surprised how much coverage is required. T10 is often the most affordable. In 10 years, you will probably need less insurance but it will be more expensive than buying T20. Many people buy T10 with renewal privilege and plan to buy less insurance in ten years.

  • Marcia Stehouwer February 27, 2008, 10:27 am

    Having had some involvement in the insurance business at one time I would say this about insurance in general.
    1. Insurance should be bought when you are young – it is cheaper that way.
    2. I wish I had bought insurance for my child, since she now has insurance challenges and may find it difficult to become insured.
    3. A whole life policy is a good way to make sure the costs of dying when you are older – taxes, the second home etc., – are covered so that your estate stays intact.

  • Miso February 27, 2008, 2:24 pm

    Thank you so much! It’s so much more clear after reading your explainations!

  • messels February 27, 2008, 7:00 pm

    hopefully i’m not met w/ frowns and glares but whole-life is *hardly* a waste of money.

    what people seem to frequently forget/minimize is that in 10, 15, 20 years you may no longer qualify for life insurance, as marcia stehouwer’s _child_ is experiencing.
    i had a neighbor who was 23 years old, and i told her, you should consider getting life insurance now while it’s super cheap. she scoffed at the idea, “i don’t have kids, a home, what do i need it for?” six months later, she was in the hospital with type 2 diabetes; she’ll never qualify for life insurance, at least not at affordable rates.

    typically, i would recommend a combination of term and whole life (oh. yeah, i use to sell it. i have securities licenses etc for selling investment vehicles such as universal whole life w/ separate accounts). there are a gazillion tricks for “reducing” taxes (i.e. not paying them) by leveraging the tax statuses of life insurance.
    to put this in perspective, i have $250k in coverage (not a lot) but i’m also only carrying a student loan in debt. that being said, i’ve been considering getting more! there’s plenty of reasons for getting life insurance and waiting until the children pop out isn’t the best time to evaluate it. that’s when it should already be in place.
    get as much coverage on your kids, make it a whole life and do it as fast as possible. the whole life, if properly funded, could be come the college funding vehicle you’ve been looking for. as for you yourself (an adult), life insurance w/ a separate account is simply another way of increasing your retirement funds since after year 7 (at least in the US) you can start pumping as much money as you want into the policy and then withdraw the gains at later date without incurring capital gains taxes…at least until the amount withdrawn equals the total premiums paid. if you’ve been paying in on premiums for 40 years (25 to 65), that’s quite a bit of tax-free money. OR, you could simply stop paying on the policy since it’s cash reserves will continue to pay the premium for you. essentially, it’s a lack of understanding the in’s and out’s of a policy that prevent many people from buying into the idea.

    another part of the problem, imho, is that everyone assumes that insurance salesmen are all about making commissions. if you don’t trust the person, go somewhere else. there are plenty of honest sales people who really do just want to help you and your family.
    good luck. :)

  • JRich February 27, 2008, 11:18 pm

    messels – not sure if this is a frown or a glare

    I agree there are SOME uses for it. Tax shelterring inheritances is one good use. But the minimal tax savings that whole life can provide is far outweighed by the fact that it is a poor investment.

    Whole life, for most younger adults, is liek the bastard child of term life and ‘real’ investments. It tries to be an investment (and is poor at that). It tries to be life insurance and its poor at that because most will pay a lot more money than a term policy and get a lot less coverage.

    You probably paid a lot for that $250k policy. If you are like me – the only income and married with young children – $250k is nothing. I very strongly believe that a more adaquate term policy coupled with strong short and long term investments is the key to financial security. I have a 10 year $1mm policy for a measly $180 a year and I heavily invest.

  • Jordan February 28, 2008, 8:51 pm

    I’m coming late into this comment discussion which has a lot of info from people selling the product. The question I have to ask other families is what is the purpose of life insurance? Is it to provide for your family until retirement? Is it a million dollar windfall to fully pay for all of your kids to go to university and so you’re partner won’t have to work for 20+ years?

    Personally I have 2 kids and a stay at home wife. So I too feel the need to provide to them as much as possible, but if I die I think life insurance is only there to cover needs, not wants. So for us that need is to give my partner say 5-7 years to get back on her feet. We live a frugal life style so this shouldn’t be hard to continue. Our large non-retirement savings plus some term insurance should only need to cover housing, living expenses and enough so she can complete her degree or other training so she can begin supporting the family. It’s very reasonable to assume she won’t live the next 60 years alone, I expect she would find someone else and re-marry. I don’t see why people associate dying with paying off the mortgage. Why can’t it just pay the mortgage for 5-7 years? Then the widow will continue on with life like everyone else, continue to save for retirement and the kid’s education, and paying the rest of the mortgage over time.

  • DJ February 28, 2008, 10:11 pm

    Jordan,
    I can only answer for my own situation. My Dad, who was in the insurance business, recently passed away at 55 years old. He was underinsured, with only $250K of insurance. My mom, who hasn’t worked since 1980 and is now 60 years old, was left with no mortgage (thanks to the insurance) but $250,000 in debt because my Dad took out a HELOC to fund his retirement portfolio, assuming that he could pay it off over the next 10 years working before he fully retired. Unfortunately, that was not the case. My mom was left with a sizable retirement fund, which she doesn’t want to access right now otherwise she won’t have enough to live a hopefully long life off of, but she was also left with a fair amount of debt. The three kids did not receive any inheritance and two of us are putting ourselves through university and getting into debt. My Dad had planned to pay for our education once we were finished (pay off our loans) but didn’t provide for that with his life insurance.

    Insurance isn’t meant to be a windfall or a lottery type deal. It’s not a “bet” against yourself with the insurance company. It’s about preserving your estate, providing you with comfort and providing for your family after you’re gone. A reputable insurance agent won’t sell you more insurance than you “need” but will ensure that you have the right amount for your needs and your families needs. In your situation, that might be less than another person in your position.

    Let me ask you one more question regarding your response…if you did pass away, would you want your wife to have to rely on another man providing for her? Would you want her to feel that she HAD to remarry in order to live? What if she decided not to remarry for whatever reason? These are some of the tough questions you have to face in estate planning and unfortunately, a lot of clients are afraid to even go there and so they avoid insurance all together.

    Just my 2 cents. Incidentally, I’m a big fan of critical illness insurance. If only my Dad had it, it could perhaps have helped him find treatment but unfortunately he didn’t necessarily have access to liquid cash and didn’t want to withdraw money from RRSP’s etc. or take out loans that would put his family’s future in jeopardy…that’s just the way he was. He thought that he would get better and didn’t, and by the time he realized that it was more serious than he thought, it was too late…

    Disclaimer: *I am NOT a licensed insurance salesperson or financial planner*

  • Ramis February 28, 2008, 10:33 pm

    I believe Critical insurance is one of the most important coverages and everyone should have it, although one of the most expensive type of coverage there are term coverages you can purchase or “Accelerated health care” which will pay you a portion of your life coverage.

    CI wasnt invented by an insurance company but rather by a surgeon, so it shows you the importance of the coverage.

  • Jordan February 28, 2008, 10:48 pm

    I don’t mean to be insensitive but could your father really have paid off a $250,000 HELOC and university for 3 kids in say 10 years before retiring? It seems like even if he didn’t die you’d still be in a similar situation. The insurance shouldn’t be there to fix the real problem of under-saving for retirement and education.

    I guess my situation is different then a lot of other people. I don’t really believe in having consumer debt, we just save up to buy things instead of borrowing.

    Our family’s bare living costs are about $40,000/year, we don’t current have a mortgage, but either way the monthly payment would be taken care of for those 5-7 years. By starting our kid’s education funds from birth, even in the worst case scenario they will still have a significant portion of it paid for.

    I’m not rich, but according to the life insurance estimator’s online, with the needs I’ve put in it says I don’t need any insurance at all.

    To answer your question I absolutely think the best decision my hypothetical widow could make would be to find another husband. Primarily because I wouldn’t want my children to be raised without a father, I think single parenthood is an extreme burden, I think it would make her happy to share her life with someone, and I think in our generation it is nearly essential to have a partner to be financially secure.

    Even if she doesn’t she should be able to support the kids, no she won’t be retiring young like we’re currently working towards, but that’s ok. Everyone will still have a normal life.

    It is a bet and more people should be aware of the real odds, and the costs of living in debt which includes paying higher premiums for a bigger safety net.

  • Telly February 29, 2008, 2:02 pm

    FT, My husband and I are in a similar situation to your current situation (two equal incomes, no dependants) so we haven’t had the need for life or mortgage insurance to date. But I do remember someone pointing out that life insurance policies should be based on two incomes rather than one, especially for younger couples. As you said, no one wants to predict or think about their death but the truth is, for younger couples, often death or disability is a result of a car accident, and in many cases, both spouses are involved in the accident. I know this sounds horribly morbid and, as I mentioned, I know very little about insurance so this may have been someone practicing their sales pitch ;) but I just thought I’d mention it.

    Any thoughts on this?

    • FrugalTrader February 29, 2008, 2:22 pm

      Telly, what we did was instead of purchasing one joint first to die policy, we essentially purchased 2 policies. So if one spouse passed, then the life insurance proceeds + spouse income would be enough to live. If we both passed, then the combined proceeds from both policies would go to the child.

      I will get into the numbers in Mondays post (hopefully).

  • Ramis February 29, 2008, 2:32 pm

    FT why not joint-first to die policy? it will be cheaper in premium instead of 2 policies and would still serve its purpose.

    Telly: that depends on the type of policy and the purpose of the insurance. if it’s there for mortgage than a join first to die policy equal to the amount of your mortgage would be sufficient. If it is in terms of estate planning or equalization than obviously different aspects need to be taken into account.

    Actually death or disability from car accident is only a very small portion, like someone mentioned CI has become a very big issue. Before working as a financial planner I used to work with a collection agency and well over 75% default accounts were due to some critical illness.

    • FrugalTrader February 29, 2008, 2:41 pm

      We went with the manulife product. They don’t have a single joint first to die product, but have a “family” type product with basically double the coverage. We worked out the premiums to be a little less than 2 separate policies of the same amount.

  • DJ February 29, 2008, 3:09 pm

    I think bare minimum, one should have enough to cover funeral expenses and all debts. I still think it’s important to have enough coverage to have some money for spouse and children but everybody has their own values, I suppose.

    That’s a real good point about the car accident scenario. If both spouses die in a car accident, what then would happen to their minor children if there was no insurance?

    Good call FT on the family plan insurance. That way you’re both protected as well as your estate and any children/dependants in the unfortunate event of the death of both you and your spouse.

  • Bryce February 29, 2008, 3:16 pm

    I could be wrong but I believe it’s pretty common for first to die policies to pay out double in the case that both people on the policy die at the same time.

  • Bryce February 29, 2008, 3:19 pm

    Here is an AIG policy (I don’t work for them it was just one I looked at before)
    http://www.aiglife.ca/wave/english/Product%20Information/Term%20Life/Term%20Insurance%20Product%20Overview%20-%20215E.pdf
    Apparently it pays double if both die within 60 days of each other.

  • Ramis February 29, 2008, 3:22 pm

    yes some insurance companies do still have that option on. Also if someone dies as a result of an accident the payout is doubled, this options comes build in some policies and as a rider on other policies.

  • Life insurance Canada March 23, 2008, 1:49 pm

    I agree with you that people don’t like planning for what happens after their death, but even though it’s not pleasant subject, they should think about it. Another problem is that even when they are conscious about the subject, it’s hard to find the right insurance and the right company. I found some useful Life insurance tips for people who cannot decide which company is best for them and which kind of Life insurance they should choose.

  • JR April 6, 2008, 4:29 pm

    LIFE INSURANCE NEEDS CHANGE WITH TIME.

    Use them for two reasons only, that is if you care about the ones you leave behind.

    1 & 2:

    1) Tax and estate planning

    2) Early death, leaving enough for the family to sustain for at least 10-years

    But as part of your overal life plan, watch the cost of doing this.

    I know folks that have purchased huge sums, both term and universal life, joint, first to die last to die, term 100 etc.

    I have universal & term

    Inside the universal I have investments tax free

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