If you're anything like me, your first experience with life insurance was with a pushy whole life insurance salesman who might have managed to convince you to buy a ridiculously expensive and low return policy. When my husband and I were first married, we fell for this sales pitch, and opted into a whole life policy that was hella expensive. To the tune of $200 a month for approximately $200K in coverage each.
Purchasing these policies as the biggest technical money management error in my life.
Whole life insurance policies are basically policies designed to keep you broke forever and provide next to no benefits in the event of your death. Upon studying these policies, there is approximately one legitimate use for the policies which has to do with extraordinarily risk averse, extraordinarily rich people in their mid-fifties hoping to eliminate tax burdens on their endowments which is approximately .001% of the population. If you're in that .001% of the population, then congratulations, you weren't a sucker for buying a whole life insurance policy, as long as you bought it at age 50 instead of age 25.
That being said, I believe that being appropriately insured is an important part of everybody's financial plan, but it was tough to find information on how much I should specifically be insuring given my situation. So after collating information from all over the internet, I present to you the Definitive Guide to Building your Life Insurance Ladder.* Please note that I am completely untrained in any of the financial dark arts.
Principles Building Your Life Insurance Ladders
This life insurance guide is founded on the principles that certain events will trigger your need to buy life insurance, and that you should buy policies specific to that event for the expected term of the event, and you should terminate policies that are no longer necessary. The overlap of the various policies is your "ladder." I don't really know what else to call it, because visually, a ladder makes the most sense, but in my mind I think of each of the policies as blanket of various thicknesses designed to protect my loved ones from the cold.
I adapted this method from a pretty sweet website called Quotacy.com which provides a visual breakdown of the amount of insurance required to meet various needs. I thought this was pretty awesome, but that the site fell short in one small area which is that it grouped all the needs into a single policy instead of separating them.
Buying multiple life insurance policies might seem cumbersome, but your life insurance needs will change and having multiple policies will give you more flexibility to change your coverage as your needs change.
There are five events that I will cover in detail in this guide.
Five Life Events that Trigger Need for Life Insurance
Each of these events signify that you have a joint relational and fiscal responsibility to uphold, and in the event of your death, somebody else will bear the weight of that responsibility. The kindest thing to do, is to set that person up to succeed in fulfilling that responsibility by providing them with the necessary financial means to succeed.
One way to provide the financial means is to have the money (invested in stocks, real estate, cash, etc.) and specifying in your will who should receive it and for what purpose. The other way to provide the financial means is to purchase a life insurance policy and specify who the recipient should be. If you are rich, then you don't need life insurance. If you are pre-rich then you do, if any of the five events apply to you.
I will go into specifics on the amount and term you should purchase for each of the five events.
For the purpose of this guide there are really only four numbers you need to know:
Taking on Unsecured Debt with a Cosigner
Event Description: Taking on unsecured debt with a cosigner is common if you have poor credit or if you took on private student loans. Federal student loans have a convenient death clause, so if you die your debt is forgiven. Not so with those private loans. If your parents cosigned your loans, then they will be liable to pay. This is also true with car leases, credit cards (that are held in both you and your spouses names), and any type of shared consumer debt.
Why do I need life insurance: When you take on debt with a cosigner, that person will be on the hook for your debt even in the event of your death. In the event of your death, you are adding financial stress to grief if you do not have the means to pay off your debt.
How much life insurance do I need: You should take on a term life insurance policy for the whole amount owed unless you have significant easy to sell assets that offset how much debt is owed. Used cars and real estate aren't easy to sell, so unless you own stocks, bonds, or cash that is greater than the amount due its best to take out the full amount. For example, if you take out 33K to pay for college, then you should have a 35K insurance policy to cover that.
Who is the beneficiary: Whoever co-signed the loans with you. In many cases, this will be your parents.
What term should I get: If you have consumer debt of any sort (including student loans), you should have a plan to pay it off, and the plan should be faster than the full term of the debt which is typically 20-30 years. If you've got an aggressive plan to pay the debt off from the point that you take it on, then a ten year term should be sufficient (yes, even if you take on the debt at age 18), but a 15 year term is probably best for most consumers.
Cost: For a healthy, 18 year old female buying a $50K for a 15 year term the cost is $71.50 per year according to Quotacy.com
When should I cancel: Cancel the life insurance as soon as you have paid off the debt.
Taking on secured debt with a cosigner
Event Description: The most common form of secured (or asset-backed credit) is a mortgage or another for of real estate loan. If you take out a business loan with a business partner, or take on debt to buy a rental property with your brother, or you take on a mortgage to buy a primary home with your spouse then you have a shared fiscal and relational responsibility to enable the other person to pay back the debt in the event of your passing.
Why do I need life insurance: Typically, any sort of joint debt (even investment debt) assumes that both partners can financially back the debt. In the event of your death, the investment or purchase may become financially unviable. A life insurance policy will assure that your partner can immediately pay off the debt upon your death. It is wise for both partners to have a life insurance policy with the beneficiary being the other person.
How much life insurance do I need: Take out a term life insurance policy for the entire principal balance on the loan. Even though your balance will diminish over time, it's better to be a bit over-insured.
Who is the beneficiary: Whoever co-signed the loan with you. Most of the time this will be your spouse, but it could be a business partner.
What term should I get: Your term should correspond to the life of the loan. If you got a 30 year mortgage, then get a 30 year term insurance. If you got a 7 year business loan, then get a 10 year insurance policy.
Cost: For a healthy 30 year old female buying a $300K for a 30 year term, the cost is $225 per year according to Quotacy.com
When should I cancel: Cancel the life insurance policy as soon as you have paid off your debt .
Event Description: Going to the chapel or the court house and getting married.
Why do I need life insurance: Life insurance can be seen as a final gift to your spouse, but more importantly, your spouse is going to undergo a massive life change. Giving them the financial means to maintain a state of normalcy for a few years will allow them the necessary time to grieve and adjust to their new life. Additionally, your spouse may need extra money to move closer to their family, or downshift in their career while they grieve.
How much life insurance do I need: You need enough life insurance, so that your spouse can step out of his/her life for several years without causing serious financial distress. Since your mortgage and other unsecured debts have already been covered with other rungs, a good rule of thumb is for both spouses to be covered at 3-10X your combined salary.
Who is the beneficiary: Your spouse will be the beneficiary. Both husband and wife should get equal coverage despite differences in earning.
What term should I get: Most people won't be able to offer this gift of time for their spouse until close to the point where they've reached financial independence, so getting a 30 year term is a reasonable guess for most people.
Cost: For a healthy 30 year old female buying $600K for a 30 year term, the cost is $382 per year according to Quotacy.com
When should I cancel: Cancel this policy when your liquid net worth (Cash, stocks, retirement, etc.) is equal to 25 times your family's annual spending rate.
Event Description: When ankle biters enter your life, you'll know.
Why do I need life insurance: Although logically most of the child rearing costs are covered in your family's spending, it is important to be realistic about your spouse's ability to generate income while running a single family house. In addition to increased childcare costs, your spouse is likely to have to cut down on earnings opportunities in order to provide a more stable home life for your children. For single parents this is even more important because you will be asking somebody else to care for your children as they grow up.
How much life insurance do I need: If you are a single parent, you should have at least $250K per child, as this is the amount you will want to leave to whoever it is that will be raising your children. This amount won't cover college, wedding costs, or any huge milestones- if providing those are important to you, you may want to tack on additional $100K. Each parent in two parent households should hold $125K-$250K per minor child. This amount will cover the increased childcare costs, convenience costs, and decreased ability to work that result from running a single parent household. Households with more children can sneak towards the lower end of the insurance spectrum.
Who is the beneficiary: In most cases the beneficiary will be your spouse, but if you are a single parent the beneficiary should be a trust for your children.
What term should I get: Either 15 or 20 year term will be sufficient. If your kids are already a bit older, then 15 year term is fine. For newborns and toddlers choosing 20 years is a safe bet.
Cost: A $200K policy for a 20 year term on a healthy 30 year old female is $128 per year.
When should I cancel: Cancel this insurance when your child is no longer a minor, or when your liquid net worth is equal to 25 times your family's annual spending rate.
Event Description: Income integration occurs when the family spending (not including mortgage payments) exceeds one spouse's ability to generate income. This happens when one spouse stays home to raise children, one spouse only works part time, husband and wife own a business together, or one spouse significantly out earns the other spouse.
You and your spouse might be doubly integrated (co-own a business, dual income house where spending exceeds either spouse's paycheck, or another situation where each spouse is equally dependent upon their partner for that person's income).
On the other hand, you and your spouse might be singly integrated (family is primarily dependent upon the top earner's income).
If you are doubly integrated then both spouses require life insurance, but if you are singly integrated only the top earner needs to be insured at this level (all prior level still apply)
Why do I need life insurance: Your lifestyle is designed in such a way that one or both marriage partners are fiscally dependent upon each other. The death of the top earner (if singly dependent) or either partner (if doubly dependent) would require a significant lifestyle change. which you do not want to require of them for several years while they grieve.
How much life insurance do I need: First multiply your family's spending by 25 (ie if you spend 60K per year then 25*60K= $1.5M). If you don't know how much your family spends then multiply your combined income by 25. Now subtract the amount of life insurance that you have from the marriage step (example $500K) and now subtract your combined liquid net worth ($250K) In this example, the top earner or both partners would require an additional $750K in life insurance coverage.
Family Spending*25 - Life insurance from Marriage - Liquid Net worth= Coverage required
Who is the beneficiary: The primary beneficiary will be your spouse.
What term should I get: Your term should last only as long as you expect your incomes to be integrated (ie how long do you think one partner will be dependent upon the other). For most couples, this will be indefinite, so a 30 year term is best. However, in an example where the wife will stop working for 5 years until their child starts school, a 10 year term would be most appropriate.
Income integration is the riskiest financial situation, so it is best to err on the side of a longer term as opposed to a shorter term.
Cost: A $1M policy with a 30 year term for a healthy 30 year old female is $570 per year.
When should I cancel: You should cancel as soon as you can comfortably say your income is no longer integrated (ie stay at home spouse now fully integrated back at work, stop owning a business together and go back to work, etc.) or when your liquid net worth is equal to 25 times your annual spending.
Currently I am not as well insured as my analysis leads me to believe that I should be. I didn't add additional insurance after Kenny's birth and neither did my husband. Additionally, my husband and I are currently "income integrated" and we will be for the next three years while my husband finishes school.
At our current spending rates, it would make sense for me to take out two additional policies. One $200K 20 year term to cover the costs of raising our son, and one $250K 10 year term to cover our income integration period.
My husband should also consider taking out an additional $200K 20 year term policy to cover the cost of raising our son in the event of his death.
I definitely do not prefer to spend money on insurance (I would rather spend the money on investments or fancy food), but in the event of my death (or my husband's) this is likely to be the best money we've ever spent.
As I wrote this guide, I was surprised by how emotional the whole thing felt, so perhaps this is not nearly as definitive as I thought.
I'm a wife, a mom, an employee, and a personal finance nerd who is devoted to spreadsheeting my way through life.