How much life insurance should you have? Most people I talk to aren't sure. In this video I run through a scenario and discuss some of the things to think about. Hopefully this will give you some clarity, and help you determine what makes most sense for you and your situation.
Full Transcript:
How's it going on, everybody? It's Ryan here. Okay, so I want to talk to you a little bit about life insurance and address a question that I will commonly get asked, which is "How much life insurance do I actually need?" Now, there's several different reasons why people buy life insurance. Many people think that the only type of reason to buy life insurance is for family protection or income protection as we call it. In other words, you're the primary breadwinner and you're concerned about protecting your spouse or your kids if you were to pass away and make sure that they have the money to pay the monthly bills and such. Now, there are other reasons for life insurance. There's reasons in a business, whether you may need funding for a buy-sell agreement or for a key person life insurance policy. You may be buying life insurance to help transfer wealth down to the next generation because there can be some nice tax advantages to doing that.
There are different reasons to buy life insurance, but the most common reason again is for family protection or income protection. So, what I thought I would do is run through a scenario here with you and, hopefully, by doing so, this will give you some things to think about so that you can perhaps determine for yourself really how much coverage you actually need in your particular situation. Now, I'm a simple man so I want to keep things as simple as possible in my scenario here. So, what I'm going to say here is let's say you are exactly 50 years old and you're married and your spouse is exactly 50 years old, and you're working and not only are you the primary breadwinner, but you're the only breadwinner. Your spouse does not work outside the home.
Now, maybe you have kids. Maybe you don't have kids, but we'll kind of just leave them out of it for the sake of simplicity. Let's say, even if you have kids, they're self-supporting so not to worry about them. So, our scenario is that you're the primary breadwinner, you're 50, you're spouse is 50, and let's say you're planning to retire when you're 65. Your concern is what if you were to pass away before retirement? Because presumably, if you live until your planned retirement date, perhaps you may not need life insurance, because at that point you would have saved and accumulated enough money, enough assets, enough investments, and such for the both of you to live on for the rest of your life. But if you're 50 now and still planning to work for 15 more years, which keep in mind, it doesn't just mean that you're also not just planning to work for those 15 years and so that you're going to have the income that you need then, but chances are, you're probably also saving and/or investing money for retirement, or at least hopefully, you are.
Perhaps in a 401k plan or whatever it might be. So, if you're not around because you passed away and I hate to bring that up. But again, this is life insurance, but if you are not around, well, those contributions to those retirement plans also stop. Okay. So, another thing to consider, but again, I want to try and keep this as simple as possible, and everyone's situation is different, but here's the scenario. If you pass away, your spouse who's not working still needs to pay the monthly bills. Now, there's all kinds of fancy software and fancy calculators and such that will help spit out a number that supposedly determines how much coverage you actually need.
What I have found to be the simplest way to think about this in this type of situation is to just think about, "Okay, if you pass away, your spouse needs to pay the monthly bills each month. What are those monthly bills?" Now, I'll pick a number here. Let's say it's $8,000 a month after taxes. That's just what it costs to pay the mortgage or the rent, put food on the table, pay the insurances, all those types of things. They need $8,000 a month. Now, we know how much they need monthly. The second question is, how long do they need it for? Now, perhaps they made need that income until they're 65. Okay. So, again, they're 50 as well so that's 15 more years. Now, the reason that I say perhaps is they may get back into the workforce.
One thing to keep in mind here is that many people will try to get back into the workforce and many people do, but you always need to be careful that if a spouse has been out of the workforce for a number of years, perhaps they used to make a pretty good income. They've been out of the workforce for a while. They may not be able to just go back into the workforce and make the same kind of money. They may make significantly less. So, obviously, think about that in your case, how that would play out. So, let's say they don't go back into the workforce and they need that $8,000 a month for the next 15 years. Well, $8,000 a month is $90,000 a year. For easy math, I'm just going to say that's a hundred thousand. Multiply a hundred thousand by 15 years, that's 1.5 million that they will need to be able to live on.
Now, if you have $1.5 million sitting in savings or investments that they can tap into prior to retirement, keep in mind, this is money just to get them to age 65. Once they get to 65, there needs to be other retirement assets and things for them to be able to live on. I mean, you've got social security, but what else is there going to be? So, making sure that you've got all that in place already as well. So, if they need that 1.5 million and if you were to pass away, they get that 1.5 million, just a lump sum cash, keep in mind that when you do receive a life insurance death benefit, the proceeds are income-tax-free so they don't have to worry about paying any income taxes on that money.
Now, one thought that comes to mind is, "Well, do they really need 1.5 million?" Again, if they're going back to work, then probably not. They probably need a lower amount. Also, if their expenses aren't going to be the same $8,000 a month, and they're going to be a lower amount because perhaps they're going to reduce their lifestyle somehow. Maybe they sell a car. That could happen. Maybe you have two cars now and they can go to one car. Maybe they're going to move to a smaller home or whatever the case might be. You would just rerun those numbers based on that scenario. So, instead of $8,000 a month, it'd be something less and then do the same calculation. How many months until age 65? Okay. So, that's one thing to kind of think about when figuring out how much coverage that you're going to need.
Another thing that always comes up ... well, it doesn't always come up, but it comes up a lot, is "Well, my spouse could go ahead and just invest that money and if they invest that money, she or he wouldn't need 1.5 million because it's being invested so it's earning money as well so we could probably look at getting a smaller amount." But you have to remember that inflation is a factor as well. So, they may need $8,000 a month this year, but next year they're going to need more to keep up with the cost of living. So, you have to factor those things into the mix there when figuring out how much coverage that you actually need.
Fast forward now. Now, you're 65 years old. Let's say you're both planning to retire, and now perhaps, you may not need any life insurance at this age, because again, now, presumably, you've accumulated enough money, enough assets, and such for you to be able to live on now for the rest of your life. The only other things to make sure that you really keep in mind are the way the rules work right now with social security. Obviously, anything could change in the future, but the way the rules are now is that when one spouse passes away, you do lose a social security check. So, you keep the higher of the two, but you do lose the smaller one. So, you have to factor in that there would be less income from there. Also, if you're planning to rely upon a pension when you retire, you need to understand the survivor benefit option on that pension. In other words, if it's your pension and you pass away, what is your spouse going to get? Is it going to be half? It could be the same, but it could be half. It could be even zero.
It just depends upon what options you have. So, you do need to think about that, and sometimes life insurance can be a way in order, let's say you lose a social security check as an example, to be able to provide the money that social security check was providing. So, hopefully, that makes sense. There's a lot of different little things to kind of think about. I'm throwing a lot at you here. The one other thing to kind of consider is let's say you're 50. You need that 1.5 million, as an example. You need it now, but you won't need as much money let's say when you're 55 or 60 because let's say you didn't pass away at 50. You passed away when you were 60. Okay. 10 years from now. Well, if you pass away in 10 years at age 60, your spouse doesn't need 1.5 million because they only needed enough money to bridge the gap for the next five years until 65 until they can plan to live on the retirement monies that have been accumulated.
So, what you could consider, there's different strategies here, but you may want to ladder your life insurance policies because you can't have more than one. So, maybe you get a policy that will cover you for let's say 10 years and one that covers you for 15 years. So, as an example, you may have 750,000 or let's say a million dollars for 10 years and you might have $500,000 for a 15-year policy. So, if you passed away after age 60, there would still be 500,000. So, that could potentially reduce your costs on the insurance that you're paying at that time as well. So, lots of different factors to consider here. I hope this was helpful. If you have questions on this or questions about your particular situation, want to discuss what you need, feel free to reach out. Until next time, take care and we'll talk soon.