Today, I want to talk all about life insurance, specifically the purpose of it, the different ways to determine quote unquote, how much you should have in terms of life insurance, the two different types of policies and lastly, where to get it.
We’ve been talking about insurance. Insurance is a reminder is one of the two rails that we utilize in the financial framework to protect our wealth in life. Sadly, bad things occur, bad events occur, and sometimes there’s a financial impact to those bad events, and that’s what we’re trying to protect against.
We’re trying to protect against and minimize. The cost of the financial impact of some events occurring. Specifically, today, we’re talking about a premature death. That’s what life insurance is for.
The purpose of life insurance is to primarily provide an income for those that are financially dependent upon you should something happen to you.
Right? So, for example years ago when our kids were small, Erica was primarily a stay-at-home mom, and I was the primary provider and breadwinner for her. So, if something happened to me and I died my wife and my children who are very dependent upon my income would really be in a pickle. And so, therefore, we had life insurance to provide for them should something happen to me.
And the basic premise was that if something happened to me, Erica would get that money. She could invest it and generate a revenue stream that would essentially replace my income. That’s what the primary purpose of life insurance is for. Now there’s some secondary uses that other people use it for things like wealth building legacy planning.
So maybe you want to, you know, have life insurance so that when you die wealth is generated for the next generation, things like that. Some people utilize it for paying of estate taxes and liquidity at death. Should they need a lot of capital due to businesses buy sell agreements, things like that.
As we discussed in the order of transfers, and I’ll put a link in the show notes so that if you didn’t watch the episode, you A life insurance contract, the policy essentially is a contract between you and the insurance company. It basically says that upon my death, this amount of money will be provided to these certain beneficiaries.
It’s a contract. It must be fulfilled. And it’s important to remember that whatever the beneficiary is listed on that Policy is who the money will go to regardless of what a will or a trust document might say, because in the order of transfers of death, this is the number one way by contract. And so, if everything in my, my will says, give everything to Erica, but I have, you know, somebody else listed as a beneficiary.
The money is going to go to that beneficiary and not necessarily by what my will says. So, it’s important to make sure that you have the beneficiaries listed on your policies.
There’s a lot of instances where When people die, the insurance proceeds don’t go to the person that was maybe intended because they never went back and changes. So, for example, if a person starts working at a company and they’re very young and they list maybe their parents as the beneficiary on their group life insurance plans and then now years later they’re married and have children, but they never went back and changed it and maybe put the spouse as that beneficiary.
Well, if that person were to prematurely die, mom and dad would get the payouts from the insurance company and not the spouse and the kids. We also see this very common in divorce scenarios where husband and wife are married. You know, the spouse is the beneficiary, a divorce takes place and now maybe they’ve gotten remarried and have a family with that person.
And, but they never went back and changed them. life insurance policy and they die, and the new spouse doesn’t necessarily get the proceeds. It goes to the ex-spouse. So, it’s always important to make sure that you have the beneficiaries listed on your policies as to who you want the money to go to.
So, this then begs the question, how much insurance Should one person have or need, and there’s a handful of different ways to go about calculating it. I’m going to talk about the most common three, but there’s a couple other options as well. The first one in the easiest one is just the multiplier.
Ideally, they should have 10 to 12 times their income. So, whatever your gross income is for the year, multiply that by 10 to 12 and that’ll get you ballpark. So why 10 to 12? Let’s just take an example. Let’s say you make a hundred thousand dollars a year, so you should have a million dollars of life insurance.
Well, if you make a hundred thousand dollars a year, you don’t really bring home a hundred thousand dollars after, you know, taxes and benefits and retirement and stuff like that. You really bring home about 70 to 80 percent of your gross income, right? We refer to that as your net income. So, the idea is if you’re making a hundred thousand dollars and something happens to you and you die, your spouse then or a caretaker for children, whoever it might be, could then take that million dollars and invest it.
Well, if it’s invested properly and you’re getting, you know, eight, 10, 10, 12 times. growth rate on that money and you pull out a percent, it will then generate a revenue of about 80, 000 a year forever, which is the idea of your income has now been replaced. And so those people who are dependent upon you have a revenue stream of that 80, 000, which is what you brought home previously.
From a net perspective when you were working and that’s how we kind of replace your income. That’s how we came up with that multiplier number 10 to 12 times your gross income a little bit more sophisticated way to do. This is what’s called capital needs analysis, which is the idea that you sum up all the different amounts that you need for different goals.
So, things like how much would your funeral cost how much would potentially final expenses cost some people would say Add in how much do I need to ensure that my kids college is taken care of how much would my spouse need to maybe? Pay off the mortgage and then take that to how much would my spouse need?
And my family need in terms of income each year and you run a calculation through all of those and you add them all up and that comes with a total amount of what you would need. I have a worksheet that can help illustrate this and you calculate this. You can find it on true wealth dot show slash resources page.
You can go to true wealth dot show forward slash resources, and you’ll see it listed there with called how much. And so that’s another way of going about doing it a little bit more involved, but it’s another way. The third way. And this is kind of the most complicated of these three, which is the human value analysis, which is essentially the idea of how much value do you bring to your household, economic value minus how much do you consume, right?
So, for example maybe you bring 100, 000 a year, but you know, you have insurance needs, you have food costs, you have travel, you have entertainment, you have daily living expenses. And so maybe you, your cost as a person, how much you consume is maybe 40, 000. So, you make 100, 000, but you really net out 80, 000 minus 40, 000 that you cost.
So, if you were to pass away, your family wouldn’t have the costs associated with you anymore. Gives you a number, and then you can use a capitalization factor on that. Kind of complicated but it’s another way that some people go about doing it. So, the most basic way is just simply which I’ve used personally and generally what I use with clients, which is 10 to 12 times your income.
Now all three of these are predicated upon the idea that the primary purpose of insurance is to provide for those that are financially dependent upon you.
But if you don’t have people that are financially dependent upon you, maybe you’re single. Maybe you’ve reached a stage of life where you don’t need life insurance anymore.
That’s more of a want. So, if you’re in your, you know, 60s year, so, and you’re getting ready to retire and your kids are grown and gone, you might not need life insurance anymore. So, then it’s more of a, how much do we want to have? You know, for example, in our situation, our kids are now grown and independent.
It’s just Erica and I, Erica makes plenty enough income to provide for herself. She’s no longer dependent upon our income. We have amassed some amount of wealth. And so, if I were to pass away now economically, she’d be fine. So, we don’t necessarily need life insurance. We still have it. It’s something that I want for Erica.
It’s something Erica wants for Erica. And so, we still have it, but it’s not necessarily a need. So, it really comes down to that point of the cost trade off how much it costs by how much you want to get. And so, it’s more of a, you know, desired amount at that point.
Now, when it comes to life insurance, there’s really two different flavors of insurance.
There’s what’s called term life. And there’s what’s called permanent life. So terminal life is the idea where you have a certain amount of insurance for a certain term. Could be 10 years, 20 years, 30 years. And that policy is level. The premium is level. The death benefit is level. It’s consistent. And so that is the most basic way to get insurance, which is a term life and policy.
So, for example, if you’re in your twenties or in your thirties and you’re having Children. You’re still in childbearing years. You would generally have a 20-to-30-year term to provide for, again, your spouse and your kids or your caretaker and your kids if something were to happen to both of you, you’d have a caretaker taking care of your kids.
And so that’s the most basic way to have insurance. There’s no savings element. It’s just straight. You’re paying for insurance, and something happens to you, you get insurance. That’s all there is to it. This is generally the cheapest way. It’s the simplest way. And. You know, some people say, well, what if, but when that term is expired, if I need more, well, if, if you’re in good health wise and you’re insurable, you could always get more.
Now it’s going to cost more. So, for example, the policies that I got in my late twenties costs less than the policies that I got in my late thirties. And if I were to get new policies now in my mid-forties, they would cost more than when I got them. Earlier as, as a person ages, there’s a higher probability of death and therefore higher probability of a payout from life insurance.
So, the premiums cost more. So, to combat that, some people. Recommend the idea of getting permanent insurance. And when it comes to permanent insurance, there’s really two aspects of it. There’s the insurance component, and then there’s the savings component. So, the idea with that is you get the policy price for your entire life.
So, in your twenties, thirties, forties, it’s cheaper than it is in your fifties, sixties, and seventies. And so, they calculate what it would cost to insure you for your entire amount. When you’re younger. A portion of that premium that you’re paying every month, or every year goes into a savings component and then it kind of grows and grows and grows and then when you’re older What you’re paying in doesn’t cover all the insurance needs of it.
And so they kind of start Pulling out of that savings component to make the premium the same throughout a little bit more involved and then there’s kind of two other flavors of that Permanent insurance one is called universal Type of insurance, which is the idea where you have flexibility where you can change the death benefit You can change how much you pay things like that And then there’s what’s called a variable life insurance policy Which is the idea where you can control what that savings account is invested in So instead of just going to savings it can be invested and it can grow and it can help some of the offset some of those problems premium costs later, a little bit more involved.
And maybe in the future episodes, we’ll do a deep dive on all of those. But permanent insurance is, there’s some benefits to it, especially kind of for those secondary uses of legacy planning things, wealth building, liquidity at death, estate planning needs, business you know, buy sell agreements, things like that for the average person.
Term insurance is going to be your better option in my opinion. There, but there are maybe some cases where permanent insurance might be beneficial for others. And full disclosure, I don’t have any permanent insurance. I’ve never bought any. I’ve had some that was given to me when I was earlier in my life, but I’ve never bought any.
I just haven’t had the desire for it. It’s a lot more expensive costs a lot more. And really from my perspective. You know, unless you’re trying to hit one of those secondary goals, the average person, they don’t need permanent insurance. If you do the things that we’re teaching here, which is, you know, essentially this framework we’re going to start walking through and you build wealth, there’s not going to be a permanent need for insurance.
Like our illustration, our life is a perfect example. When we were young and we had kids and we were broken and we didn’t have any money, we had a big need for life insurance, but come now 20 years later after doing this stuff there’s not as much of a need for life insurance. Like I said, we’ve amassed wealth.
Our children are grown and gone. Erica has a good paying job. She could provide for herself if something happened to me.
So that covers the types of insurance. So, the last question is, okay, where to get it? And just like all insurance, really, there’s about two or three different places to get it. The first one is through work group benefits. Some employers offer life insurance as a benefit, either something that you pay for, something that they pay for or combination thereof.
Generally. It’s not the cheapest place to get it, but sometimes it’s a good way to get it. Especially if you have. Some underlying health issues. They might not make you go through medical screening to get it. And so that might be an option for some people. The second place to get it is through again, a captive or a general agent.
So, if you go to an agent that works for a specific insurance company, they’re representing that company. They can help you get life insurance through that specific company. The best way in my opinion to get it is through a life insurance broker that will shop amongst many different carriers and companies and get you the best deal.
It’s a highly competitive area, so pricing changes a lot and so therefore it’s always good to explore, you know, all the different options out there.
Your micro action for the week. Pull out your life insurance policies. Look at the coverage to ensure that its enough coverage given your life circumstances, where you are in your stage of life.
And number two, more importantly, check the beneficiary information is still accurate given your life situation. So, this amount will get paid to this beneficiary upon your death. That is probably the most important thing.
And this episode we talked about life insurance. We talked specifically about life insurance. The purposes of it, the different ways, how much one might need, how much you should have the two different flavors of policies. And lastly, where to get it.
If you have any questions, you can leave them in the comments below or send an email to Mike at true wealth dot show. Hope this helps you on your financial journey and until next time, have a great day.
