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What Life Insurance Should I get

Not long ago I was considering whether to decrease my life insurance coverage through my employer.  We have an Employer based Life Insurance Policy and a separate Term Life Policy.  The following is a culmination of that investigation.

Employer Life Insurance Policy

If you work for a large company you likely have some sort of Life Insurance buried in your benefits. It is most likely 1x your pay.   This should be enough to allow your significant other to recover from the initial shock of your death and pay for burial.  The bigger issue is your spouse has now lost access to your income.   The 1x your pay is not enough to replace the missing income over the subsequent years.   This is fine if you do not depend on your spouse’s income, but otherwise will leave you in a world of trouble.   As such if you’re​ married with kids, or have any other dependents, I would recommend increasing your life insurance beyond this point.  You do not want to have those who are left behind struggling to make ends meet on top of mourning.

While I advise purchasing more life insurance I believe it is better to purchase additional coverage outside your employer plan for 2 reasons.  Consider shopping both within and outside your employer plan for the following reasons:

  1. While Life Insurance in amounts below 50K paid for by your employer are tax free, the cost of a benefit exceeding this amount if paid for with pre tax funds are taxed as something called Imputed Income. Essentially tax is added based on the coverage over 50K divided by 1000 multiplied by a value in the below table.  The table amount is chosen based on your age and multiplied again by 12 months.  Finally the resulting value is subtracted by any portion you personally chip in after tax.  This amount is then taxed as ordinary income.   This may make the life insurance more expensive through your employer after accounting for discounts from insurance bundling via a private carrier.  In the past I have had cases where adding life insurance to my car insurance company resulted in a discount on car insurance roughly equal to the cost of the life insurance policy.
    Imputed Tax=((Total group term coverage – $50,000) / 1,000) x rate for employee’s age from table below
- employee after-tax contributions for the year x 12 months

    AgeCost Factor per 1000 per Month
    Under 25                      0.05
    25 to 29                      0.06
    30 to 34                      0.08
    35 to 39                      0.09
    40 to 44                      0.10
    45 to 49                      0.15
    50 to 54                      0.23
    55 to 59                      0.43
    60 to 64                      0.66
    65 to 69                      1.27
    70 and older                      2.06

    So, a quick example.  If I am 35 and I have 100K in coverage, then my imputed tax would be (100K-50K)/1000*.09*12 or 54 dollars.  Not a huge dollar value but greater than 0.

  2. Not all Life Insurances persist when you leave an employer. Before counting on an employer life insurance policy you should check if it will be possible to continue should you leave your employer without an additional health screening. You should also check what the rate will be in this case. The last thing you would want is to have an illness force you from a job and then no longer be able to get insurance.

We currently keep 50K in Employer Life Insurance, thus avoiding any imputed taxation.

Term Versus Whole Life

If you do decide to purchase coverage outside your employer you must choose between Term and Whole Life Insurance.

Term insurance is purchased to cover a period of a number of years, with the most common being 20 or 30 years. Generally these policies are cheap and are purchasable with a fixed premium over that term. Some companies will even adjust your payout amount for inflation, commonly called an inflation rider, for a larger fee.

Meanwhile, just as the name implies Whole Life Insurance is purchased for your entire life. Usually Whole Life not only insures you for your entire life but also accrues a cash surrender value. That cash accrual usually occurs at some fixed rate plus a variable amount acting as a kind of savings account. Often times the dividends off this cash surrender value can be used to pay your premiums once you’ve held it long enough. This is most likely the case if your parents, like millions of others, bought you a policy as a kid. Be sure to check with your parents if you have such a policy as they are often forgotten.

Insurance should not be an Investment Vehicle

In theory the Whole Life Policy is a better deal, but in practice it is almost always not. The biggest issues are :

  • A low rate of return compared to the stock market or other investments.  Essentially Whole Life Policies are invested in low risk investments for the insurance company to ensure they can pay your premium. As such they will lag riskier assets like the stock market.
  • Typically High fees, which eat into the returns.  Fees on whole life policies can be excessive, they are also not easily comparable to other investment options. They can include sales commissions and ongoing costs.
  •  You may not require insurance for your entire life.  At some point you may become financially independent. That point when your dependents are out of the house and you have enough to retire and no longer work. At that point there is no longer a reason to buy life insurance. By buying a whole life insurance policy you are also paying for that period of your life whether you need it or not.
  • Counter Party Risk.  If the insurance company becomes insolvent you could see an increase in fees or a decrease in cash value. You are betting on the long term health of the insurance company. Note there are state level protections to ensure your entire policy remains in tact, but as noted the terms can change.

For those who view whole life insurance as an investment in your heir’s future, for the above reasons I ask you to reconsider. If you do not need it to allow a dependent or spouse to solider on in your absence, it is highly likely your dependents will be better served by other investments. After all, if it was such a good deal over other investments the insurance companies wouldn’t sell it. Why? They have to invest your premium behind the scenes to keep themselves in existence and make a profit, they do so by investing in low risk assets.  They have access to the same underlying investments you do.  Thus their product’s return must always be at least lower than your potential investment returns by their overhead plus whatever profit the company makes.  If a salesmen earns a commission the rate of return could be even lower.

How long a Term to Buy

So basically that leaves us with a purchase of Term Life. In order to determine the correct term for you, evaluate how far into the future you will have a dependent depending on you. Also, consider at what point you and your spouse will be financially set to retire. (Note for the purposes here I mean retire with no more work, not retire with side gigs). Calculate out when that leaves you and buy a term that matches that time period. The shorter the period the lower the cost. I currently carry 20 years of Term Life. This will carry me to my oldest son’s senior year and my youngest’s freshman year of college. At that point I expect to be sunsetting my career. I had considered 30 years but ultimately I decided based on my current financial trajectory this was a safe point to stop coverage.

How much Life Insurance should I Buy?

The final question is how much? Some would like enough to retire should their spouse pass, which would be your retirement number – your current net worth. However, I would personally recommend at least 5x your pay. This means for 5 years the missing pay will not be noticed. My rationale is 5 years is long enough for my wife to modify her career trajectory to account for my missing income.   That being said my wife has an engineering degree and a successful career history to fall back on in my absence.  If that is not the case you might be better off with the retire approach.  Ultimately, this is a deeply personal question you should discuss with your partner.

What type of life insurance do you carry?

17 Comments

  1. Leo T. Ly
    Leo T. Ly April 21, 2017

    When I first bought life insurance, I did not know much about life insurance. The insurance agent was a friend of a friend, so I trusted her to provide me with the correct advice. I ended up buying whole life insurance equivalent to 10 times my salary at that time.

    After I got married and had kids, I bought term life for my spouse (to protect me lol) and kids. Coincidentally, the term life date on the insurance expires a few years after my FIRE date. I fluked out because I had no idea what my FIRE date was at that time.

    If I have to do it again now, I would buy term life for all my family members.

    • fulltimefinance@fulltimefinance.com
      [email protected] April 22, 2017

      For much of my pre children life I also sort of lived dangerously on life insurance. I think I had about one times my pay for the first year of my marriage. I didn’t start thinking of these things until kids entered the picture, but I probably at least should have considered it even if it led to the same decision.

  2. We both have policies through my husband’s employer, but it’s on my financial to-do list to get us both a separate term policy outside of that. We’ve followed the rule of having about 4-5 times my husband’s income, but it’s been harder to determine how much to have on me, since I’m currently a stay-at-home mom. Ultimately, we decided to get an amount that would cover additional childcare, cleaning, and such if I were to pass so my family could have a comfortable, less stressful life. Because that’s what life insurance is for, right?

    • fulltimefinance@fulltimefinance.com
      [email protected] April 22, 2017

      Currently my wife has about two years of expenses in insurance as a stay at home mom/contractor. That’s enough to cover child care for much of the path to 18. I agree, life insurance is about less stress. It’s a deeply personal question.

  3. The Magic Bean Counter
    The Magic Bean Counter April 21, 2017

    Nice write up. This is something I have been meaning to sit down and get sorted out myself. I lean more towards a term life policy as well. Just makes more sense.

    • fulltimefinance@fulltimefinance.com
      [email protected] April 22, 2017

      The big advice is try not to procrastinate. It’s easy to ignore life insurance until it’s too late.

  4. Torch Red
    Torch Red April 21, 2017

    This post is very well articulated. I think that the insurance industry scares us into purchasing way more life insurance than we actually need. I totally agree with you on term vs whole life and not using insurance as an investment vehicle. My wife and I have good careers and make very similar salaries. The similar salaries makes my situation a little different. We have two pre-teens who are no longer in daycare. Here is my thought process:

    My wife and I have a high savings rate and high charitable contribution rate. Both of these, along with taxes flex with income. Our 529 savings for our kids is well funded and requires only a few hundred dollars a month of contributions (fixed cash outflow). Our only debt is a mortgage. We are age 35-40 now and on pace to 100% retire in 15-20 years. We each have life insurance in the amount of our mortgage, rounded up to the next whole multiple of salary. If one spouse dies, the surviving spouse gets ~50% of the original income, 0% of the debt, 50% of savings and charity and taxes, and somewhere between 50-80% of the variable costs. And the thing most people forget is that the surviving spouse has twice the nest egg per head than before and will probably marry a new spouse with their own nest egg. It’s hard to imagine a situation where this surviving spouse is not better off financially both in terms of meeting month-to-month needs and in terms of age to 100% retire. And this is with life insurance of about 2x salary per person (enough to cover any remaining debt). If both spouses die, our net worth is already more than adequate to support our kids while they live with an aunt/uncle and pay for their college.

    Such a low multiple of salary works because: 1) both spouses have full-time careers with similar salaries, 2) savings rate is already high, 3) debt load is low and 4) nest egg is already robust.

    • fulltimefinance@fulltimefinance.com
      [email protected] April 22, 2017

      Sounds like a very well thought out plan. Your risk tolerance and your salaries heavily factor into the question of how much. I’m sure if our salaries were equal my families plan would be different.

  5. Mustard Seed Money
    Mustard Seed Money April 21, 2017

    I have life insurance through work that provides 5x my income. So at this point I feel like I have enough coverage but I am definitely like you. I am not a fan of whole life insurance and definitely think term life insurance is the way to go.

    • fulltimefinance@fulltimefinance.com
      [email protected] April 22, 2017

      Have you explored what happens to that insurance if your let go from your employer? Also I gather your approaching FI, any thoughts to self insuring?

  6. Grant
    Grant April 22, 2017

    People should absolutely have some life insurance but every situation is so unique it is difficult to give rules. A lot of the recommendations I read are way too high in my opinion. I would rather invest that extra monthly expense into a 529 plan.

    My wife and I both work and have an infant in daycare. We have enough to pay off the mortgage and cover two years of living expenses.

    There is also social security benefits which people rarely take into account. My wife would receive almost $4,000 a month if I were to die today. Go to ssa.gov to check your benefits. It is quite amazing if you have never looked.

    • fulltimefinance@fulltimefinance.com
      [email protected] April 22, 2017

      Great add on he social security survivor benefit. The only problem is the amount gets larger with how long you’ve worked, which is probably the exact opposite of what most require.

  7. Ms. Frugal Asian Finance
    Ms. Frugal Asian Finance April 22, 2017

    Interesting post! I got my life insurance through my employer. The payout is 3 times my salary, which many people told me is pretty good. Mr. FAF will get his through his new employer.

    • fulltimefinance@fulltimefinance.com
      [email protected] April 22, 2017

      3x is not a bad starting point. Do you have kids? Any other people reliant on your income? How do you and your spouses income relate? Any debts? These are really the questions you should be asking when determining the amount you need.

  8. Troy @ Market History
    Troy @ Market History April 23, 2017

    I don’t have life insurance. Don’t plan on getting hitched in at least 10 years, so I’m just enjoying the single life right now and all it’s financial benefits.

  9. Jack Catchem
    Jack Catchem April 24, 2017

    Do I have life insurance? Oh I have life insurance! Thanks to the nature of my life’s calling and my father’s unfortunate early passing, I have enough life insurance to pay off my absurdity of a mortgage and provide 6-7 years of income to my wife in the event I catch a slight case of death. Sadly I have to pay 3x as much as my wife thanks to my father’s untimely passing at 40.

    Still, it is a comfort to know there’s a solid backup plan if I do silly things at work. Oddly enough I can’t fathom gambling with money, but I’ve always been extremely comfortable gambling with my body.

    • fulltimefinance@fulltimefinance.com
      [email protected] April 25, 2017

      The lifespan of those that came before certainly weighs in. My fathers still doing fine but my grandfather passed at forty. My insurer didn’t hold it against me but it certainly influences my own decisions.

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