How Much Life Insurance Coverage Is Necessary For Income Replacement?

Income replacement is one of the biggest things to consider when determining the amount of coverage needed in a life insurance policy. Financial professionals offer several different formulas to calculate income replacement. One of the simplest formulas takes your annual income and subtracts your personal expenses. For example, let’s say you bring home $50,000 per year. Some of that money will be spent on your personal needs (not family needs). If you are no longer alive, then you are no longer spending money on personal needs. That’s why personal expenses are subtracted from annual income. A common assumption is that 25% of your annual income is devoted to personal expenses. Financial professionals recommend a minimum of 5 years income replacement.

There are some decent life insurance calculators available, but one assumption they all make is that your income is the only income that needs replacement. Grieving affects many things, including job performance. Some surviving spouses may require a long time to grieve, so their job performance may be affected long term. Grief may even cause someone to lose a job. I don’t claim to know the statistics on grieving and job performance, but one thing makes intuitive sense: jobs that require a great deal of creativity are most affected by grieving. On the other hand, jobs that require repetitive manual labor are probably the least affected.

Job performance may also be affected if the surviving spouse has young children. Time may be needed away from work in order for a parent to provide emotional support for grieving children. In conclusion, it’s good to consider the income of both spouses for life insurance coverage even though only one spouse is being insured with the policy. If you have any questions, don’t hesitate to send me a message.

Term Life Versus Whole Life

I roll my eyes every time I hear the phrase, “Buy term and invest the difference.” This strategy relies on two assumptions. The first assumption is that people are disciplined enough to invest the difference. The second assumption is a belief that investments will be profitable. Term life insurance is best for temporary needs such as mortgage protection and income replacement. Whole life, on the other hand, is best for funding a cremation or burial. In fact, small whole life policies are often referred to as burial insurance or final expense insurance.

Many people lose their term life policies because they experienced a financial hardship and couldn’t pay the premiums. Term life offers very little to prevent a nonpayment cancellation other than a 30 day grace period and a chance to reinstate. Whole life has automatic premium loans to pay premiums when you can’t. Premium loans are made possible by a policy’s cash value. Whole life has cash value and term life doesn’t.

There is a false dichotomy that says people should either have term insurance or permanent insurance. The best financial experts advocate a blended approach, where consumers own both types of policies at the same time. Many people find themselves in financial trouble when they exclusively use term insurance. In order for me to explain why, you first have to understand something about term insurance. Term insurance is meant to insure someone for a highly unlikely death. Death becomes more likely as people age. Insurance companies eventually stop writing term insurance after a certain age because death is no longer unlikely. Permanent insurance, on the other hand, is meant to cover everyone until they die. Death is a certainty in this case. The only thing in question is the expected age of death. Since people often need life insurance for their entire lifetime, and options for term insurance diminish as a person ages, permanent insurance eventually becomes a better option than term insurance. Unfortunately, if people exclusively use term insurance until it is no longer a good option, the cost of buying permanent insurance (whole life) might be unaffordable. That’s why you should buy term life and whole life at the same time.