Today’s post comes from a young practicing accountant. He asks:
Sir,Now that I will soon be married, do I need life insurance for my spouse and I?
As with all good financial planning questions, his question needs to be answered with another question:
Do you (or your spouse) depend on each other’s income?
If you answered “yes,” follow this simple formula to determine how much life term life insurance you need:
the amount of your annual need divided by a sustainable withdrawal rate (such as 2%)
So, if your spouse will need $10,000 of income each year (in the event you die), divide $10,000 by 2% to get $500,000. Don’t let the figure of $500,000 scare you away; a $500,000 term life policy can usually be had for just a few hundred dollars a year.
To bring this point home, let’s use an example with a fictional Deloitte employee, Susie Savesalot, CPA:
Susie earns $50,000 a year working at Deloitte. Her husband also earns $50,000. That makes for a household income of $100,000. Between the two of them, Susie and her husband spend $65,000 every year. Were Susie to pass unexpectedly, her husband would be unable to pay $15,000 of expenses each year. If Susie wants her husband to enjoy the same lifestyle he enjoys now (i.e. keep spending $65,000 every year), Susie should get a $750,000 term life insurance policy on herself. ($15,000 ÷ 2% = $750,000.) Susie’s husband will be the named beneficiary of the life insurance policy.
The same applies for Susie’s husband; he also needs a $750,000 life insurance policy, with Susie named as the beneficiary.
The above example is a little simple because it assumes that in Susie’s passing her surviving husband would be spending the same amount every year. This may (or may not) be realistic. In addition to a change in expenses, the passing of a spouse might also mean a change in income.
Using Life Insurance: Real Life Case Studies
My wife and I don’t depend on the other’s income a lot; i.e. we each make enough money to mostly support ourselves. This made our answer to the life insurance question relatively simple: get a small life insurance policy on each of us – just enough to cover our joint mortgage debt.
The life insurance policies ensure that neither of us are stuck with the responsibility of bearing the full mortgage payment on one income. The insurance benefit is just big enough to pay off the balance of the mortgage. Getting the right size policy means that we’re both sufficiently insured and that we’re not spending money on coverage that we don’t need.
To be clear, I got life insurance not because we got married, but because we took out a sizable mortgage. We were married before we took out a mortgage – and before the mortgage we had no life insurance, because we didn’t need any.
What if Our Expenses are Less than Our Individual Income?
Then you don’t need life insurance – at least not right now. But remember to include any need to save for future expenses (college, retirement) when calculating your annual need. To illustrate this idea, let’s turn to our favorite fictional Deloitte employee, Joe Danger, CPA:
Joe brings in $50,000 from his job at Deloitte. His wife, Beatrice, also brings in $50,000. Therefore, their household income is $100,000. Their annual expenses tally just $40,000. So, were either Joe or Beatrice to die prematurely, the other would still be able to manage $40,000 of expenses on $50,000 of income.
Today, Joe and Beatrice do not need life insurance because each can get along fine without the other’s income. The future, however, may be a different story. While Joe and Beatrice do not have a lot of expenses now, they could have a lot of expenses in the future – especially if they intend to pay for college their six children. In short, when considering how much life insurance you need, think about not just today’s expenses, but tomorrow’s expenses as well.
Doesn’t My Employer Already Give Me Free Life Insurance?
I already shared that our family choose to obtain life insurance to cover the cost of our mortgage. I did this by purchasing private life insurance policies. Why didn’t I just rely on the life insurance policies provided by our employers?
Deloitte, PwC, EY, and KPMG offer free life insurance for their employees. However, each employer offers only very limited coverage. The free benefit is usually capped at $50,000; PwC offers just $20,000 in free protection, and EY offers an additional “Bereavement benefit” on top of their life insurance offering. However, at just four months salary (or $50,000, whichever is greater), even the EY benefit is not able to provide for decades of living expenses that your surviving dependents (spouse, children, aging parents) may require. This is why purchasing additional term life insurance can be helpful.
Should I Purchase Extra Life Insurance Through My Employer?
No. The problem with purchasing life insurance through your employer means your coverage could end when your employment ends. (This is the same problem with purchasing umbrella insurance through your employer.) You’re usually going to need life insurance longer than you’ll be at the same employer. Said another way, you’re more likely to switch jobs than you are to die prematurely. Consider how this could play out in the real world:
Joe Danger, CPA receives a small amount of life insurance for free as a benefit from his employer, Deloitte. Since he knows he needs more than the base life insurance coverage, Joe purchases several hundred thousand dollars in additional optional life insurance though Deloitte. Now, Joe’s family is fully insured in the event of Joe’s untimely passing.
Joe receives an offer from a recruiter working for PwC. Joe leaves Deloitte for the opportunity at PwC. No longer an employee at Deloitte, Joe’s life insurance coverage made through his normal paycheck deductions ends. Joe no longer has any life insurance coverage.
After Joe leave’s Deloitte, but before Joe starts working at PwC, he is killed in a car accident. During this short period of unemployment, Joe has $0 in life insurance coverage. His widow now must fend for herself and her six children without Joe’s income.
Had Joe purchased a private life insurance policy, that private policy would still be in-force regardless of Joe’s employment.
Purchasing Life Insurance
We already discussed that counting on your life insurance to be provided by your employer is a risky business because:
1.) The life insurance provided as a free benefit is rather small (between $20,000 and $100,000)