Calculating the right amount of life insurance.

How much life insurance do you need?

(From my book The Doctors Guide to Starting Your Practice Right)

The purpose of life insurance is to support the people who are dependent on your income if you die and aren’t there to provide for them anymore. This is usually your spouse and children. If you are single, there is no one depending on your income and you do not need life insurance. Don’t waste the money. Many agents will try to make you worry about getting a disease and becoming uninsurable in the future, but the odds are way in your favor that this won’t happen. Don’t buy life insurance until someone else depends on your income.

My wife worked during the first few years of our marriage and she could still take care of herself if I died. After our first child was born, she chose to stay home with him and then they both depended on me for financial support—and so I bought my first life insurance policy. Stick with term insurance and consider a twenty-year level-term policy for an amount to support your spouse and kids through college. The premium cost will stay the same for twenty years, making it easy to include in the budget.

Stay away from any life insurance product wrapped up with an investment, such as universal life. Investments are to make money for your use while you are still alive. Life insurance is for your dependents to live on if you die. Those are opposites—so don’t try to combine them. Any type of life insurance combined with an investment serves the function of providing a very nice commission for the one who sold it to you. Those commissions come right out of your pocket. Stick with a term policy and invest your money elsewhere as you see fit. If you play your cards right, after your twenty-year level term policy ends, you will no longer need any life insurance. By then, you should be able to retire, and insurance will no longer be needed to support your family if you die, since your investments will do that.

So how much insurance do you need? This is a lot like the story of Goldilocks and the Three Bears. Too little insurance and your family is not covered, and may struggle without your income. Too much, and you waste money on premiums. Just right is what you seek.

If you have calculated your net worth and have a budget, it’s not hard to come up with the amount of insurance you need. First, you will want to pay off all your debts. Second, you will need enough money to set up a fund for your dependents to live well by withdrawing four percent of the principle every year. You calculate that by multiplying the annual need by 25. Third, include enough to get your children through college. Add in any special needs, like buying a house if you don’t yet have one. Subtract any savings you already have accumulated, and any passive income or government relief you will have.

Life insurance calculation example

Let’s look at an example of a new doctor in the first year of practice whose spouse doesn’t work, who has two children and $250,000 in loans, and rents a house. Their annual budgetary need with the loans paid off is $80,000 gross, before taxes.
They also have $20,000 in savings and no passive income.

Total outstanding debt = $250,000

Cost of college for the kids = $25,000 per year for each = $200,000

Enough to buy a house for the family = $400,000

Annual budget needs at a 4% withdrawal rate = $80,000 x 25 = $2,000,000

Subtract the savings = -$20,000

The total required = $2,830,000

Based on these numbers, a reasonable amount of life insurance for this family is a $3 million twenty-year level term policy.

Did you find this information helpful? Do you have any other helpful ideas about life insurance? If so, I would love to hear your comments.

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5 thoughts on “Calculating the right amount of life insurance.”

  1. Good short article. It’s hard not to get pulled into the sales pitches like “whole life is a great place to park cash – like a high interest savings account but with tax-free interest.” Problem is, you still pay for the cost of insurance, fees and, like you said, the hefty commission that goes to the agent (usually the entire 1st year premium up front and then 5% of your annual premium every year).

    • You can drop insurance when others are no longer dependent on your ability to earn money. Certainly if you are retired, that condition is met. (That is when I dropped my life and disability insurances) But you don’t have to be retired. Once you reach a state of financial independence, you don’t need those insurances anymore. I should have dropped my insurance sooner, as I was financially independent a few years before I actually left medicine. When it only cost $1,000 to keep a $1,000,000 policy in force for another year, it is psychologically hard to get rid of it. But the $1,000 is better used elsewhere.

  2. Cory is right. I am a dentist, now retired, and I followed the plan that Cory has outlined during my years of practice. Fortunately I discovered term life insurance in the early days of my practice when it was not common and used it as he outlines to protect my family and my practice. I only purchased the amount needed for the situation and when I no longer needed it I cancelled the policy. Wish I had had the benefit of Cory’s analysis at the time, but basically I did what he advocates and it worked well.

    Dr Jack E Luce


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