One of the first things that happen when you have kids – in addition to learning how to scrub spit-up from every type of fabric imaginable — is that you become acutely aware that you’re mortal. This young creature before you is now your charge and if something happens to you they need to be properly cared for. After the inevitable existential crisis and scotch-and-rumination-by-lamplight sessions this brings on, the next responsible thing to do is buy life insurance. And when you buy life insurance, you’ll just feel better.
Now, the prospect of buying insurance is as daunting as your inevitable demise; that’s because there are different tiers of coverage and different numbers to consider and what if you buy the wrong one and your family isn’t covered when you’re dead and they lose the house and…? Relax. It’s not as complicated as it often sounds. And you’ll feel so much better when your children are taken over. That’s why I’ve offered this helpful guide. Follow it and you’ll have a better idea of how much you’ll need and how to go about buying it.
What Type of Life Insurance Is Right For Me?
Insurance breaks down into two main categories; term and permanent insurance. Here’s a breakdown of each.
- Term Insurance
The Low Down: This is the most basic form of life insurance. The term describes how long the policy lasts, assuming you keep paying premiums (the cost of maintaining the insurance). The most common term lengths are 10, 15, 20 and 30-years.
How Does It Work? If you die during the term period, a benefit will be paid to a named beneficiary. In most cases, this is the surviving spouse. It’s that simple and, because it’s that simple, term insurance is often the most cost-effective way to go.
Understand That: One downside to term insurance is that the policy expires at the end of the term. However, many allow you, the insured, the right to convert all or some of the policy’s benefit amount to permanent coverage during the term period. Basically, this means that you have the right to extend some or all your coverage across your entire life without having to prove further insurability. Each carrier is different, but it can be as easy as completing a simple form and paying the new premium amount.
Best For: Those looking for the lowest cost option with some flexibility for something more permanent down the line will find term to be the most practical form of insurance to buy right now. For new dads, I generally see 20-year and 30-year policies being used the most since we generally are trying to protect ourselves for the long-term. That’s a good move. For example, my daughter will be finishing college 22-years from now and my wife and I just took out a 30-year mortgage, so buying a 30-year term policy made the most sense for us.
- Permanent Insurance
The Low Down: This is insurance that lasts your entire life. If you kick the bucket at any time you own the policy, the benefit is paid.
How Does It Work? Instead of the policy’s term being a set number of years, the “term” is now your entire life. Naturally, this is going to make things more expensive (i.e approximately 3-7 times more), but some people are willing to pay more to know that they will always be covered due to life’s uncertainties.
Understand That: These types of permanent policies should only be used in very specific cases and, generally, be avoided when your primary goal is to protect your loved ones. They can be even more expensive and, honestly, I tend to be wary of professionals pushing these types of policies to new families who are cost contentious. They pay generous commissions when sold, so agents sometimes feel more compelled to sell them.
Best For: People who want coverage for their entire life and can also afford to allocate more of their monthly budget to insurance are going. Permanent policies featuring an investment component are generally reserved for those looking to save more for retirement and other long-term financial goals (above and beyond what they can put in their retirement plans) because of certain tax advantages associated with these policies. Both, however, can be good tools for estate planning purposes, which, can be reserved for another time.
How Much Insurance Should I Buy?
Generally, the first question people ask when it comes to life insurance is how much to buy. While there isn’t a one size fits all policy, there are two main ways to help you figure out how much coverage is appropriate.
- Human Life Value Approach
This approach is designed to determine how much is needed based on the financial loss that would occur should an income producing spouse, or significant other, die. Human life value focuses on the loss of income that would have been provided to the family over the career of the decedent – a fancy way for saying the dead. When calculating this amount, we look to factors such as age, one’s gender, anticipated retirement age, income (after-tax) and benefits. In its most simplistic form, take your after-tax pay and multiply by your number of working years (yes, you can assume that you will indeed “retire” at some point). Then, make some adjustments for large expenses such as college education, weddings, mortgages and other large liabilities.
- The Needs Approach
Another way to tackle how much to buy is to consider what your family would need should you or your spouse pass away. In other words, how much money is needed at death to cover your family’s expenses so that things continue to run as smoothly as possible? Such expenses include, but are not limited to, burial cost and immediate cash needs, taxes, legal fees, emergency funds, housing/mortgage expenses, education costs, childcare, and personal maintenance. Add your expenses up and multiply by the length of time the expenses are needed to be covered (you can adjust for that fact that some last longer than others). Then, subtract what assets you currently have that could lower these costs. What’s left is how much insurance you should consider buying. This approach usually results in purchasing more insurance than the others, but that’s not a bad thing. Life tends to get more complex for us dads, not less.
If you’d like some help with calculating how much to buy, there are some great calculators out there that you can use for free. I like Bankrate.com. I recently ran it and found it to be quite close to the coverage I bought for my family. There’s also a very detailed calculator at lifehappens.org, which I found to lean a bit heavy with calculating my coverage.
3. Which Parent Should Be Covered? What About Stay-At-Home Parents?
The bread winners definitely need insurance. But if your spouse is a stay-at-home parent, they’re still extremely important. You generally want to see some coverage on low earning or non-working spouses, too. So, to cover them, you’d be wise to purchase a policy that’s one-quarter to one-half that of the higher earning spouse to handle this impact.
Now, when you’re ready to purchase some, I highly recommend you work with a CFP® professional. A CFP® Pro likely to take the time to figure exactly how much you need and what policy is right for you by first understanding your financial situation before making a recommendation. If they don’t sell insurance themselves, they likely can refer you to reputable agent that does.