How much life insurance do you need?
“ON THIS TEAM WE FIGHT FOR THAT INCH…
On this team we tear ourselves and everyone else around us to pieces for that inch. We claw with our fingernails for that inch.
Because we know when we add up all those inches that’s going to make the f—–g difference between winning and losing. Between livin’ and dying.”
I’ve always loved those words given by Al Pacino’s character at the end of Any Given Sunday right before the big game.
Why? Because I firmly believe that in the finance and investing game you have to FIGHT FOR EVERY SINGLE INCH you get.
Nobody is going to hand you squat.
And if you don’t, you’ll find yourselves waking up at 60, filling in an application for a job at Wal-Mart.
(I know it seems I always pick on Wal-Mart, and I do. But I can because I know of people personally who have unexpectedly faced the horror of a Wal-Mart job application instead of their dreams of retirement).
And I’m going to do everything in my power to make sure that doesn’t happen to you because you’re going to be older way longer then you’re going to be younger.
So today I’m going to begin officially helping you learn how to fight for that inch by introducing you to guest writer and insurance expert Glenn S. Daily.
Glenn runs a consulting service designed to help people like us make “good decisions about insurance.”
I was referred to him by a fellow named James Hunt – another insurance expert – after I hired him to help my brother-in-law Mitch decide if his life insurance policy was the right policy for him.
Let me explain:
Recently I became aware that my brother-in-law Mitch purchased a life insurance policy from somebody we’ll call Agent-X.
Now Mitch is a very intelligent man: he’s a physician’s assistant (PA) for a very well respected neurologist down here in Florida. On subjects ranging from complex new medical treatments to world history and current affairs, Mitch is as well versed as anybody.
But, like most people, finance is like a foreign language to him.
That’s why – during casual conversation with him a month or so ago – I learned that Mitch bought a life insurance policy from his bosses life insurance agent.
I’m going to skip the fancy names and just say that in all likelihood, Mitch bought a policy that simply wasn’t the best policy he could buy.
Now I don’t claim to be an expert on life insurance. In fact, I could honestly say that it is one of my least enjoyable subjects to study…
…but knowing enough to know whether you’re getting hustled or not is critical if you’re going to fight for that inch.
That’s how I got in touch with James and Glenn.
It seems that the critical issue in determining whether a policy like Mitchell’s is indeed good for you is based on answering the following question:
“Could you do better if you buy term insurance and invest the rest?”
But today I’m getting ahead of myself.
First, you have to decide how much life insurance you need before you tackle the harder issues.
Here’s what Glenn had to say about that:
How much life insurance do you need?
It depends on what you’re trying to accomplish. Life insurance can help your family maintain its current standard of living after you die. It can provide money to pay estate taxes or to equalize the shares of an estate among the heirs or to repay a loan.
Protecting a family’s living standard is the most common use, and there are many ways to calculate the amount of life insurance needed. A simple method is to multiply your annual income by a factor, such as 10. However, this method is too simple to be reliable, because it doesn’t take into account your specific goals and resources.
There are many calculators on the Internet that estimate life insurance needs by gathering information about goals and resources and then computing the shortfall. The results can vary greatly, depending on the methodology and the assumptions.
A better approach is to use ESPlanner (www.esplanner.com), a financial planning program that tells you the maximum sustainable standard of living that is consistent with all of the assumptions that you provide.
Unlike Internet calculators, ESPlanner produces a life insurance needs estimate that takes account of your other financial planning goals, including retirement planning and education funding.
ESPlanner also estimates your future life insurance needs, not just your current need. This is important, because it will give you a clue about what type of life insurance to buy. For example, if your need declines gradually over the next 20 years, a combination of 10-year term and 20-year term might be appropriate.
ESPlanner may give you a very different picture than you will get from Internet calculators, insurance agents or even financial planners. And as a bonus, you get an entire financial plan, not just an estimate of your life insurance need.
If you prefer a quick-and-dirty estimate, without the oversimplification of the multiple-of-income approach, you can make use of a mathematical trick.
Suppose you want your spouse to have an inflation-adjusted, after-tax annual income of $50,000 a year for 30 years. If you assume that the after-tax rate of return on the invested life insurance proceeds is equal to the rate of inflation, you can calculate the present value of that goal by multiplying the annual income by the number of years; i.e., $50,000 x 30 = $1.5 million. If you expect that the investment rate of return will exceed inflation, make a downward adjustment; say, to $1.3 million. If you expect that the investment rate of return will be less than inflation, make an upward adjustment; say, to $1.7 million.
For each after-death objective that you identify (e.g., living expenses, education expenses, mortgage payoff), compute how much money would be needed today to cover the cost.
Then make a list of the resources that will be available (e.g., invested assets, Social Security, pension), and compute their present value. The difference between the present value of the after-death objectives and the present value of the available resources is your life insurance need.
But ESPlanner is better.
Whatever method you use, don’t get hung up on precision. Every needs calculation is based on many uncertain assumptions. Your goal should be to buy enough life insurance so that your family has some acceptable options upon your premature death. Let the human capacity to adapt take over from there.
(Glenn S. Daily is a fee-only insurance consultant in New York City. For more information please visit www.glenndaily.com).