Life Insurance

Fundamentals of Market Investing by Adam J. McKee

Life insurance is designed to pay your family what amounts to your income in case you do not die and are not there to provide that income.  It does a very good job of that, but that is the end of the story.  Your goal with insurance is to protect you, your family, and your property from the possibly catastrophic downside risk of unexpected and often terrible events.  Insurance is not an investment, or at least it is not a good one anyway.  Don’t let a commissioned agent tell you any different.  Insurance is not a legacy.  Don’t leave your kids an inheritance via life insurance.  You don’t buy insurance because it is the responsible thing to do, you buy insurance because you have responsibilities.

The amount of insurance you have should be aligned with your responsibilities.  If you have three small children and a spouse, then you need an amount of insurance equal to the money you’d make working until retirement age.  That will come out somewhere in the ballpark of $1.5 Million for the average American worker.  Or will it?

Remember, there will be no taxes or deductions coming out of that insurance money, so you need to calculate it based on the income that you take home.  Further, all of the expenses that you currently pay to maintain you are no longer necessary.  My point is that, like everything else to do with money, you don’t know what you need until you put numbers into a spreadsheet.  Our estimations of how much money we will need to retire and maintain our current lifestyle are often grossly wrong.  How much insurance we need is likely the same way.

As you grow older, your life situation changes.  Student loans and mortgages are paid off (hopefully).  Kids grow up, and, hopefully, they get careers of their own and meet their own financial needs.  Not everything gets cheaper.  Medical expenses go up, and you need to visit the doctor more frequently.  Still, for most of us, our net worth goes up over time.  Unless you are reckless, your debt load should go down over time.  If this is the case, then your responsibilities for which you need to work for money become less and less over time.  As morbid as it is to point out, the longer you live, the better your chances of dying.  Nobody lives forever, and age is correlated with mortality.  Insurance companies know this, and they charge you more money the older you get.  By the time you are ready to retire, you should have all the money you will ever need in your retirement savings account, your home, and your other investments.  What do you need expensive insurance for?

My premise is simple.  Term life is the cheapest life insurance around, and there will be the cheapest policy that you can get.  When you are very young, buy a very cheap policy that covers you for a long term.  After the term expires, recalibrate your needs and buy a new policy with a lot less coverage.  Another thing to consider is that your retirement savings are often paid to your designated beneficiary as a death benefit (check your plan carefully).

If you have $250,000 in your IRA, it means that you need less life insurance than you did when you had zero in your IRA.  The difference between the term policy and the whole life policy is substantial, and you can realize the magic of compounding interest on that money by investing in your IRA rather than the insurance agent’s.  The “cash value” that your policy can build is nothing compared to what it would be in your tax-sheltered retirement account with a thoughtful allocation of assets.

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