isn’t free, of course. And, like other companies, insurance companies are in business to turn a profit. So you want to make sure you obtain proper insurance protection at a competitive price and buy only the coverage you need.
In this chapter, we dive into the details regarding life and disability insurance you may need. Here we also discuss your employment income and how best to protect it. Finally we also cover the importance of making the most of your health to minimize the chances of future insurance claims. If your health isn’t good as you enter retirement, you’re going to have more issues to face than just those dealing with your personal finances. So getting your health in order is important.
Needing insurance is kind of like needing a parachute: If you don’t have it the first time you need it, chances are you won’t need it again. Regarding your need for life insurance, of course, you don’t get second chances. (Unless you’re considering near-death experiences; and the life insurer doesn’t pay out for those!) So if you “need” life insurance, you should get it as soon as possible.
The following sections explain what life insurance can do for you. They also help you determine whether you need insurance, and if you do, how much you should consider buying.
Understanding the purpose of life insurance
The primary reason to consider buying life insurance is to provide financially for those who are dependent on your employment income. However, just because you have a job, earn employment income, and have dependents (children, a spouse, and so on) doesn’t mean that you need life insurance.
So how do you know whether you need life insurance coverage? Your current financial situation is an important factor in determining your need. If you haven’t already assessed your retirement plan and tallied your assets and liabilities, be sure to read Chapter 3.
On the other hand, you may find that even though you’re still working, you’ve achieved financial independence. In other words, you’ve accumulated enough assets to be able to actually retire and no longer need to earn employment income.
For example, consider one extreme: Microsoft founder Bill Gates has dependents and he doesn’t need life insurance to protect his current income. That’s because he has billions in investments and other assets to provide for his dependents. Of course, the rest of us aren’t Bill Gates! But we bring up this enormously successful entrepreneur in this discussion to drive home the crucial point that if you’ve accumulated significant enough assets compared to your annual living expenses, you may not need life insurance.
Determining your life insurance need
Each person’s circumstances vary tremendously, so in this section we don’t tell you specifically how much life insurance to get. Instead, we show you the factors you need to look at in order to determine that amount. We’re not fans of general rules like getting ten times your annual income in coverage, especially for those approaching or already in their senior years. The reason? Each person’s circumstances can vary tremendously among many factors such as
✓ Your assets: Generally speaking, the more you have relative to your income and obligations, the less life insurance you need.
✓ Your debts: Of course, not all debts are created equal. Debts on real estate or small businesses tend to have lower interest rates, and the interest is often tax-deductible. But the more of this type of debt you have, the more life insurance you may need. On the other hand, consumer debt – such as credit card and auto loan debt – tends to be at higher interest rates, and the interest generally isn’t tax-deductible. But again, the more of this debt you have, the more life insurance you’re likely to need.
✓ Your health and the health of your family members: If you have major medical problems or have a family member who’s ill or who has special needs, you may need more coverage.
✓ The number of children you need to put through college: A four-year college education, especially at private schools, is a major expense. So, if you have kids to put through school – and they may attend costly schools – you could be talking some really big bucks. And you face even bigger bucks if you want to help them through graduate or professional school after college.
✓ Whether you’ll have elderly parents to assist: Of course, this factor is difficult to predict, but you should have some sense of your parent’s physical and financial health. If you don’t, try to broach the topic in a sensitive fashion with them.
1. Determine your annual after-tax income (from working, not investments).
You can find this number on your tax return or W-2 form from the past year. (The reason you work with after-tax income is because life insurance death benefit payouts aren’t taxed.)
2. Determine the amount of money you need in order to replace your income for the appropriate number of years.
You can find this amount by simply using the information in Table 2-1.
3. Consider your overall financial situation and whether you need to replace all your income over the time period you chose in Step 2.
High income earners who live well beneath their means may not want or need to replace all their income. If you’re in this category and determine that you don’t need to replace all your income, apply an appropriate percentage.
Table 2-1 Calculating Your Life Insurance Needs
Assessing your current life coverage
Before you rush out to buy life insurance, make sure you first assess how much coverage you may have through your employer and through Social Security. The amount of coverage you have could reduce the amount you need to purchase independently. Employer-based life insurance coverage is an easier issue to deal with compared to Social Security survivor’s benefits, so we address it first.
Employer-based life insurance
Some employers offer life insurance coverage. If it’s free, by all means factor it into your calculations for how much additional coverage you may need. (Refer to the preceding section, “Determining your life insurance need,” for more on calculating the coverage you need.)
For example, if your employer gives you $50,000 in life insurance without cost – and in Table 2-1 you calculated you should have $300,000 of coverage – simply subtract the $50,000 your employer provides to come up with $250,000 of life insurance you need to get on your own.
Keep in mind, however, if you leave the employer, you’ll most likely lose the provided insurance coverage. At that time, if your needs haven’t changed, you’ll need to replace the employer coverage.
