Buying life insurance is an exercise in thinking about the facts of life we’d rather not ponder.  Included is an in depth example of what a family could do to make sure they are protected. We hope this info will help you line up your life insurance for good and never have to worry about it again!

Your spouse and children would be devastated if you met an untimely death. At least emotionally devastated. They could be financially destroyed, too - but not if you plan for the worst and get enough life insurance to meet their needs. 

Here are the main things that you should consider when setting up your life insurance:

• What are your current expenses?
• What are future expenses you will contribute to if you’re around (like college for your kids)?
• What expenses would your spouse have if you weren’t there?
• Do you want a guaranteed life insurance payout regardless of how old you are when you die?

Your answers to these questions will determine both what type of life insurance you need as well how much you’ll want to purchase. 

Term Life Insurance

Term life insurance is for a set period of time, generally a minimum of 10 years and a maximum of 30 years. Premiums are fixed for the entire length of the term. The shorter the term, the lower the premium. 

Term life insurance is best if there are specific expenses you want to make sure are covered in case of your death, and those expenses are time-sensitive. 

For example, you might want to ensure that your spouse is able to pay off your mortgage or that your children can pay for college. If, 30 years from now, your mortgage will be paid off and your children will have already gone to college, a life insurance plan that expires in 30 years might be the best solution for you. 

To save a little money on premiums and avoid over insuring yourself, you can stagger your life insurance coverage by purchasing multiple policies at different terms. This is also known as laddering your policies. For example, maybe your mortgage will be paid off 10 years from now but your children won’t be finished with college until 20 years from now. You could purchase one "mortgage payoff" 10-year term life insurance policy, and another "college fund" 20-year term insurance policy. 

Other forms of Life Insurance

Term life insurance is the most straight forward, and best bang for your buck type of life insurance available. However, your insurance agent's job is to try to sell you on fancy life insurance plans like annuities, whole life, permanent, universal etc. 

Permanent life insurance is a sure thing. At some point, you are going to die. Whether that is six months from now or 60 years from now, if you have permanent life insurance the beneficiaries will get a payout when you pass away. 

These policies have a cash value that, in some circumstances, can be borrowed from while you are still alive. They work like a unique type of savings account - one with a variety of tax benefits, depending on the exact type of life insurance - for your intended beneficiaries. If you need the money at any time, you can take it out. But you know that when the Grim Reaper comes calling, your heirs will be getting an insurance payout. 

For households that are already good at saving and seeking to get the most value, term life will stand out as the best option.  For households that want to get into one of these advanced policies, consider the following. Generally the permanent, whole life, and annuity style plans are  more expensive. That is because you are on the hook to contribute cash on top of the insurance premium each period. That cash is sort of still yours but it is not entirely under your control. The philosophy of the Wealth Meta staff is that mixing insurance with a savings account a) greatly complicates the issue, especially considering how horrible the idea of loosing a loved one is, b) involves more sales commissions to your broker which you are paying but don't necessarily see, and c) allows the insurance company to hold a significant portion of your wealth in an account you don't have much control over.

How Much Coverage?

Let’s go back to those questions at the beginning. You’ll want to have enough coverage that your survivors could:

• Pay for your funeral
• Pay off the mortgage and any other joint debts
• Pay education expenses for any children you have (or plan to have in the future)
• Pay for your household’s other expenses for several years

While you don’t want to overbuy life insurance, you should err on the side of more coverage. Keep in mind that your spouse might be unable to work for a period of time after your death, or that he or she might find it impossible to continue in his or her previous career.

A quick rule of thumb is:

Ten times income, plus current debts, with a term that lasts until the youngest child is over 18. 

The intention of the rule of thumb is, if in the horrible event that one spouse dies, the other spouse will be able to semi-retire and will not need to worry about earning an income for a good long time. The amount required can easily be $1M or more! 

For a newly married couple in their 20s being so aggressive about life insurance may seem unnecessary. Priorities change once you have 3 kids, a mortgage, and you are in your 40s. At that point the same coverage is going to be much more expensive, not only because of your age, but also because as life goes on people accumulate medical diagnoses that can bump them into a higher risk pool.

As stated earlier, you don't have to buy a single 30 year policy. You could stagger them: a 10 year policy to cover expenses related to child care, and 20 year policy for college and the mortgage, and a 30 year policy to guarantee a solid retirement.

Social Security May Help

Some good news - if you are in the United States and you've been working for a number of years your family is likely eligible for the Social Security survivor benefit. The rules are complex, but roughly stated the benefit goes to dependent children under age 18, and for widowed spouses who care for children of the deceased under 16 and have an income under a certain (fairly low) income threshold.

You can find your benefit at the Social Security website. Both you and your spouse will need to register for access individually. After signing up the website provides an estimate of what your survivor benefit would be. Besides it is good to have an account to check up on your expected retirement benefits. 

Note that as your dependent children age the total benefit amount drops. As you work and earn credits the monthly benefit increases slightly. The rules are somewhat arcane and there are limits. Factoring in this benefit may allow you to purchase less life insurance coverage and save some money. For example, if your monthly social security survivor payout would be $2,000, and your youngest is 8 years old, that would be a total of $240,000 over ten years going to the family. That money would cover a gap similar to what a 10 year life insurance policy would, so no need to double insure that.

Where to buy a policy?

Life insurance is a commodity, like potatoes and lumber.  Thankfully for you there are dozens of companies in the market. That means the pricing is darn competitive. To get the best deal, cut out the middleman. Quotes from your neighborhood insurance agent may not be not be as competitive as a national broker or online service (though it doesn't hurt to check).  Sites like selectquote.com, lifequotes.com (ugly but has lots of pricing detail), or quickquote.com should give you some ideas.

Only go with a highly rated insurer. You need a company that will still be around in 30 years. Pass on no-name outfits with a low rates – too good to be true. Make sure to check out the companies you are serious about for complaints.  Here are some links to pages that have life insurance provider ratings: Consumer Affairs, Nerd Wallet, Insure.com.

Finally, to get a good rate, make sure the policy requires a medical exam.  Be completely honest about prior health conditions, driving record, etc. Lying on a life insurance application can get you denied (and make it harder to re-apply), or in extreme cases give the insurer a reason to refuse paying the claim in the event of death.  Be aware that life insurance companies are very touchy about drug use of any kind, alcohol abuse or a history of alcohol abuse with continued use, smoking, and injury prone hobbies such as sky diving.

Detailed Example:

Consider a family, John and Jane, with two children, aged 3 and 6.

They have the following debts:

• $250k on their mortgage (22 years left)
• $25k in student loan debt (18 years left)
• $25k in car debt (4 years left).  

Their household expenses are $50k/year.  

Their goal is to assist both kids with college, $60k each.

Jane makes $75k/year and gets the family’s heath insurance through work.

John works part time and earns $15k/year but sends most time watching the kids

Going with the rule of thumb above (10x income, plus debts, plus college), they could both buy a 30 year policy for $1.3M. 

$300k (debts) + [10 years * $90k (income)]  + [2 * $60k] (college) = ~$1.3M.

Two $1.3M policies with a 30 year term are going to be pretty expensive. That approach is over insuring expenses associated with the kids when they are little. To save money they might ladder the policies like so:

• 30 year for $400k  - setup for retirement, clean up unknowns
• 20 year for $900k  - pay off debts, ensure kids get to college

If they are trying even harder to zero in on their needs, they could ladder the policies even further:

• 30 year for $300k  - setup for retirement, clean up unknowns
• 20 year for $600k  - pay off debts, ensure kids get to college
• 10 year for $400k  - cover short term needs with the kids

Instead of using income for the rule of thumb, Jane and John could look at their actual expenses. Figuring out actual expenses gets complicated because if either partner dies, the surviving spouse will likely need to cut back on work, plus get health insurance for the family squared away, and possibly find additional child care providers. These are NOT fun scenarios to compute! For sake of argument, let's say expenses are estimated to be $70k/year.

$300k (debts) +  [ 10 years * $70k (expenses) ]  + [2 * $60k] (college) = ~$1.1M.

For accuracy sake, we could also count social security survivor benefits as 'free insurance'.  Keep in mind there are strings attached, income limits, etc, so we'll be very conservative. Jane has a $2500/month Social Security survivor benefit, but John's is only $500/month.  If Jane dies tomorrow it would pay out $2500/month over 15 years ($450k non discounted face value).  John's would be $500/month over 15 years ($90k non discounted face value).  Based on the age of the kids, let's assume the social security benefit is equivalent to a 10 year policy worth one third of the non discounted face value - $150k for Jane, $30k for John.  Why assume one third for 10 years? Seems to be a conservative estimate given the payout will last at most 15 years given the youngest child is 3 (these payments stop when the child reaches 18), not to mention the income limits and other rules related to using the benefit.

In this scenario, they could ladder the policies like so:

Jane:

• 30 year policy for $300k  - setup for retirement, clean up unknowns
• 20 year policy for $300k  - pay off debts, ensure kids get to college
• 10 year policy for $350k  - cover short term needs with the kids
• Social security survivor benefit, estimated at a value of $150k 

John:

• 30 year policy for $300k  - setup for retirement, clean up unknowns
• 20 year policy for $300k  - pay off debts, ensure kids get to college
• 10 year policy for $470k  - covering short term needs with the kids
• Social security survivor benefit, estimated at a value of $30k 

Note that John needs to carry more short term coverage because his social security survivor benefit is less.

The process of getting life insurance isn’t much fun. The medical exam is annoying, and it can take weeks to get an approval, leaving you ample time to ponder your own demise. Our advice is to get it done correctly, once and for all.  Do it at the same time as your will and other estate planning see our article on that. Then you can sleep easy knowing that your spouse and children would be taken care of financially if you meet an untimely end.