How much do I need and for what term? Nine Year Mortgage Comments.
Nine Year Mortgage believes that life insurance coverage should be an essential part of every married person’s financial life, especially when children are present. The following information will give guidance on how much insurance to buy, and how long to keep it.
Nine Year Mortgage outlines how to calculate how much coverage you need
There are six major issues that life insurance must provide for. For the primary wage earner, these are:
- Pay off the home mortgage
- Pay off all other debts
- Cover funeral expenses
- Provide an income for surviving spouse so that work is optional,
- Provide for college education for dependents
- Cover income taxes due on large estates
For example, a married 35 year old father with 3 children under the age of 10 who earns $60,000 per year might go through the following calculation:
- Pay off mortgage = $200,000
- Pay off other debts = $35,000
- Funeral expenses = $15,000 (costs can vary substantially)
- Provide $45,000 per year in income for surviving spouse so she won’t have to go to work.
- College education for the kids $100,000 each.
- No large estate (will leave less than $3 million, which is not subject to tax)
Since the mortgage is paid off, a nest egg of $1,000,000 earning 6% before taxes will generate $45,000 per year without dissipating principal, unless interest earnings are very bad over the years.
TOTAL LIFE INSURANCE NEEDED = $1,550,000. (note this is about 25 times income)
Over the years, Nine Year Mortgage has had clients who have passed away, and when this has happens, the universal issue, which is worst in younger deaths where there are children, is the terrible and empty loss endured by the survivors. Even if the kids are in high school or college, death is a cruel blow, emotionally and financially, and our experience is that most people are UNDER insured.
How long a term should you choose? Nine Year Mortgage Answers
How long should the coverage last? Let’s move forward with the father above. If he had purchased a 30 year level term policy at age 25, then by age 55 when this policy runs out, he would have provided for the kids college education and if he manages his finances properly, he could have his house paid off. By this time his wife may have gone back to work since the kids are out of the house, so she won’t need such a generous income. He might be able to drop his coverage down to $500,000. But what about his health? Who can guarantee it will still be good?
Even if his health is still good, since he is now age 55, and the cost of another 20 years worth of coverage for $500,000 will be nearly equal to what the $1,550,000 policy cost at age 25.
So, does he need any coverage at all? Would he want to leave an estate and help provide for his grandchildren? How about donating to a favorite charity at his death? Will the wife have a pension, and if not, then will Social Security be sufficient for her needs?
These are issues for the family to discuss, in consultation with their children and grandchildren. If he wants insurance but can’t get it, he will be sorry he didn’t purchase more, or set aside the money for whole (permanent) coverage when he was younger, even though it’s much more expensive.
EXAMPLE: $1,550,000 of permanent coverage for a healthy male, age 25, will cost about $12,000 per year, or about $1000/month. Even if the policy doesn’t pay out until age 80, a permanent policy means exactly that—someone, somewhere, will get $1,550,000 upon the death of the insured.
$12,000 per year for 55 years of coverage adds up to $660,000 in premiums, or about 42 cents on the dollar. But the policy doesn’t strictly work that way—after about 25 years, it has built up cash value on which you can earn interest, and that interest can go towards paying the policy premium. This means that the total paid into the policy is down to $300,000, or about 19 cents on the dollar.
There are other uses for that cash value as well—a qualified agent can show some very attractive investment options and tax-favored income streams that can be arranged from a whole life policy.
Nine Year Mortgage wraps up on life insurance
BOTTOM LINE: The cost of life insurance will vary from family to family, but in most cases, Nine Year Mortgage encourages families to err on the side of more, rather than less coverage. It is true that the costs of permanent insurance are far higher than simple term coverage, but if bad health rears its ugly head, and term coverage runs out before the need for insurance has disappeared, there will be disappointment. Cash-value policies can never be canceled, and they also build up attractive cash accounts that have very favorable tax treatment Nine Year Mortgage recommends that these factors should be thoroughly researched before buying coverage.
For more on the difference between term and permanent life insurance see our previous post, Nine Year Mortgage on Life Insurance.
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