There are a lot of ways to answer this loaded question. It is important to keep in mind that we are not life insurance specialists and it accounts for a very small fraction of our business. However, as fiduciaries, our clients lean on us for advice in regards to all of their financial issues including life insurance. One last thing you should know is that our business has been built on financial planning and asset management that utilizes stocks, bonds, mutual funds and exchange traded funds. The reason for the disclaimers is because someone who focuses solely on life insurance for business is going to have a completely different opinion than ours. That doesn’t mean either of us is right or wrong. It just means that you should do whatever you feel is best for you.
The insurance-based planner may recommend an insurance amount that will effectively replace your income in the event of your untimely passing. For example, if you make $300k per year, you may receive a recommendation of $6 million. That number would be arrived at by dividing $300k by 5% so that your beneficiaries can live off of the 5% of $6 million or $300k. That would be at the more extreme end, but we’ve seen it. He or she may also recommend insurance as a way to save for the long term. That opens us up to a whole other discussion about permanent insurance vs. term insurance. The focus here will be solely on how much insurance you need.
Now that we’ve covered half of the article with disclaimers, let’s discuss the subject at hand. How much insurance do you need? As always, it depends on your situation. We take somewhat of a minimalist approach to insurance by helping people determine what they are trying to protect against and how long they will need that protection. When you buy insurance, you are paying an insurance company to protect you and your family from the unexpected like damage to your home, a car accident or in this case, your untimely death.
You have to think about what you would like to be taken care of in the event of your unexpected passing. The most common things that come up are household debts and children’s education. That would be a great start to determining how much insurance you need. You also have to think about how the surviving spouse will support the family even if he or she is debt free with the children’s education paid for. Some items to consider here are child care, earnings power of the surviving spouse and the excess cash flow generated from the debts to be paid off.
As you get older, your debts should shrink and your assets should grow. Your children also age as you age. In theory, this should naturally make the amount of insurance you need decrease as you get older. Think about what life will look like when your youngest child graduates from college. Hopefully, your children are more self-sufficient at that point. How much are you hoping to have in retirement assets at that time? What will your mortgage balance be? Most importantly, how much insurance would you want at that time? Maybe at that time or a period of time following it, you can be self-insured in that the assets you have saved minus your remaining debts equates to an amount that gives you enough comfort to know that your family will be safe if you were to pass away. The point is that there may come a time where you don’t need as much insurance as you need now.
In closing, how much life insurance you need depends on you and your goals. Some people want to leave behind as much money as possible no matter when they pass away. Others want to put their children in the best position to live a successful life. Once they grow up, graduate and enter the real world, the inheritance is not as significant of a concern. Maybe you need insurance to pay estate tax. Every situation is different. It may not hurt to get the opinions of an insurance salesperson and that of a true financial planner who doesn’t make a living selling insurance. Then you can decide what is best for you. As always, you should remember that if it sounds too good to be true, it probably is.