When was the last time you gave your life insurance a tune-up? Even if you once purchased an appropriate amount of life insurance, your insurance needs likely have changed as your life has progressed. If you used the popular 10-times-current-income formula to gauge your needs, the accuracy of your estimate depends on when it was made. Do this calculation early in your career, when earnings are low, and you usually end up with too little insurance. Do it during peak earning years, and you usually end up with too much.
Example: We require more coverage when we have young children and a new home than we do when the college bills and mortgage are nearly paid.
Here’s how to estimate how much life insurance you need—and when to reevaluate those needs…
Add up the following four figures for a reasonable estimate of your life insurance needs…
1. Total up your debts, including your mortgage, car loans, credit card balances and college loans.
2. Calculate your children’s remaining or future college expenses, if any, and their potential wedding expenses if you plan to pay for those. Subtract any money you have saved specifically for these expenses and any college financial aid you expect to get.
3. Add $15,000 to cover your funeral expenses.
4. Divide your current annual income in half, then multiply that figure by the number of years remaining until you retire, up to 20.
The result of adding together figures from the four steps above should provide enough income replacement for your spouse or family to live comfortably if you die prematurely.
The goal of insurance buyers is to give survivors the kind of lifestyles that they would have had if the insurance buyers were still alive and bringing in annual income. When savings are great enough to cover all future expenses, the need for insurance lessens.
Nonworking spouses do not need to use the four-step formula. Instead, they typically should have around $500,000 in life insurance coverage if the family’s children are preschoolers…around $250,000 if the children are in elementary school…and around $100,000 if the children are still at home but too old to need a nanny. These amounts should be sufficient to help the surviving working spouse cover the additional costs of child care in most regions, although the ages of the spouses, where they live and other factors could affect their needs. The amounts also should provide a bit extra to cover any reduction in wages experienced by the surviving spouse if he/she temporarily cuts back on work hours to spend more time with the kids.
Our life insurance needs change frequently, but often the best response to these changes is none at all. It can be impractical and expensive to make minor adjustments to coverage. Applying for new policies means paying the higher rates associated with a higher age. However, certain events do mean it is time to review your insurance…
Action: Canceling policies is an option, but speak with a fee-only financial planner first. (Unlike other advisers, some of whom may try to sell you extra insurance no matter what your goal, fee-only planners won’t earn a commission by selling you insurance.) Your life insurance still could be useful for estate planning. Also, some divorce agreements require former spouses to continue life insurance coverage.
Action: If you’re in your 40s or older when you remarry—but additional children seem likely—consider applying for additional term coverage immediately, before your advancing age or an unexpected health problem makes the cost of life insurance prohibitive. If property you intended to leave to children from your first marriage now seems likely to remain in the hands of your new spouse after your death, an insurance policy that names your children as beneficiaries could serve as a substitute inheritance. If new children and inheritances are not issues and your new partner is not financially dependent on you, additional insurance might not be necessary.
Action: Don’t cancel life insurance except as a last resort. Instead add coverage, if possible. Sometimes it’s possible to increase coverage without increasing bills by canceling an existing permanent life insurance policy and buying cheaper term life insurance instead.
Action: If your employer still offers free or heavily subsidized group life insurance, absolutely sign up. If your employer doesn’t provide this or cuts way back, shop around for comparable or lower term-life premiums on the open market. Individual term coverage is preferable to group coverage if the costs are comparable, because the premiums on individual policies usually are fixed for a decade or longer and you won’t lose coverage if you change jobs or lose your job.
Action: Add enough coverage to pay off the debt or pay for your child’s college tuition.
Action: If you currently have term life insurance with a fixed-premium period that will expire before your life insurance needs end, dig out your insurance contract. Does the policy have a conversion clause that allows it to be swapped for a permanent insurance policy without a new physical? Is that conversion period still open? If the answer to both questions is yes, strongly consider converting. Otherwise, you’ll find it difficult to get additional coverage at an affordable price.
Action: Canceling policies is an option, but speak with a fee-only financial planner first to confirm that this is your best option. Double-check that you truly have enough saved to provide income for your partner’s future retirement needs even if investment returns are weak and inflation surges.
Action: Wait until your kids have secure careers before reducing coverage. You may be able to cancel coverage outright if your savings are sufficient to cover remaining expenses and the cost of retirement.
Adding life insurance coverage typically means taking a physical and paying the rates associated with your current age and health. That can be prohibitive for those in their 50s or older. If it makes sense to add coverage at this stage of life, shop for a term policy with a fixed premium period of just 10 years. Such policies can have premiums that are 50% lower than 20-year fixed-term policies.
