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.