Life Insurance

"I’m married and have recently started a family. Everyone tells me that I should buy Life Insurance but there are so many policies out there, I just don’t know what to do. Help!"

“Everyone” is right. You do need life insurance, especially since you have a family who need to be taken care of if something should happen. If you’ve got a small(ish) family and an entry-level salary, you probably need at minimum a $250,000 Term-based policy for both you and your spouse; however, it might be worth looking into a $500,000 policy too. Also, don’t waste your money on purchasing a policy for your kids. Life insurance is meant to replace lost wages and unless you’ve got Jr. is working the salt mines, he doesn’t have any wages that need replacing. 

But don’t just take my word for it, let’s run through a few of your options:

Term Life: Term-based life insurance is simple, easy, and just like insuring your flatscreen at Bestbuy. You pay a set amount, say $300/year and in exchange you receive a guarantee that if you die within the term, say 30 years, your beneficiary (spouse) will receive the policy amount, say $500,000. Both the total payout and that term are negotiable but if you’re a twenty-something you shouldn’t plan on anything longer than a 30 year term because by your late 50s you should be self-insured (covered below).

Whole Life: Whole Life Insurance is essentially an annuity (think: personal pension plan) that you buy gradually over time, often coupled with a large payout similar to a term-based plan. Whole life is popular because you’re guaranteed to receive some of your money back if you don’t die. Don’t buy whole life for three reasons. 

1. You won’t always need life insurance. by the end of your term, you should be self-insured (covered below).
2. Unused life insurance is no different than unused car insurance, its guaranteed lost money that you need to have “just in case...”. If I came up with a car insurance policy that would slowly pay for the cost of the vehicle over the life of the loan (all the while you still have to be making car payments), you wouldn’t buy it. Life insurance and retirement investing is the same way. You’ll have to invest anyway, so really invest!
3. If you’re investment strategy calls for an annuity (at your age it doesn’t), then buy an annuity. If your plan calls for a higher-risk, higher-return investments (at your age it does), then buy a growth stock mutual fund. Whole life is the opposite of what you should be doing. Its an over-priced, under-performing strategy that you should just avoid.

Gerber Policies: Why would you buy a financial policy from a baby food company?! Do you also get medical advice from the snack aisle? 

Self-insuring. As mentioned above, the aim of life insurance is to cover the lost wages between now and when you are financially independent (retirement). You’re financial aim is to save enough money that even after you retire and, therefore, cease to earn additional money, you will still have enough to live on. When you reach that point, you no longer need life insurance because you are “self-insured”. Congratulations.

What term-based policy do you need? You can purchase policies of $100k, $250k, $300k, $500, $1M, etc... actually you can buy a policy in almost any amount, so why did I recommend at minimum $250k or possibly $500k if you have a higher earning? The same reason why I buy diapers at Sam’s Club, for the bulk discount. The $250k and $500k policies are by far the most popular financial product, so they are often less expensive. When I was insurance shopping, $500k was actually less expensive than a $400k policy! 

A quick and easy way to determine what policy you need is to take your annual income and multiply it by 20. This is called the “Rule of 20”. It assumes that after inflation you can expect your investments to return 5% each year. Not-so-coincidentally, this is actually the amount that you should be saving toward in retirement (less Soc. Sec. and pensions).