Everything to know about Life Insurance

You will read about everything to know about life insurance when you are expecting or have kids.  This article will help provide guidance on life insurance amount, duration and type.

For me, life was extremely hectic after having kids.  It was extra crazy as I also made the biggest purchase of my life.  We bought our home around the same time as our kid’s arrival.  The last thing I wanted to do was to commit to more big expenses during this period. 

Buying life insurance was not fun, but necessary as this was the most financially vulnerable point in my life.

Having Kids triggers the need for Life Insurance

Sometimes unfortunate things in life happen and a parent can suddenly pass away.  The best thing you can do is ensure your loved ones do not have to deal with a financial crisis in addition to facing this hardship.  This is the main reason why I chose to purchase life insurance.

To make ends meet, you can always downgrade your fancy cars or big homes to alleviate the financial strain.  This concept does not apply to kids as there is no downgrade option. You will be responsible for all their expenses until they are financially independent. 

As discussed in Future Dad Advice: 5 Things to know before you have kids, raising a kid costs an average of $14,000 per year totaling to about $235k before they head off to college.  As one of my lessons learned below, you should consider this huge expense when determining the amount of life insurance you need.

Perspective on how much you need 

There are many perspectives regarding the amount of life insurance needed.  I have seen rule of thumb estimates to target about 10-12 times your income.  There is also a more structured approach called DIME (debt, income, mortgage and education) which helps you get to a more exact amount. 

Nerd Wallet’s How much life insurance do I need? was the best article I found detailing the rule of thumb and DIME approach.   Read this article if you want to learn more about the specifics.  

What amount I purchased and the logic behind it

I purchased life insurance 7 years ago when my wife was pregnant with our first kid.  In all honesty, I did not follow any guideline then.  Instead, I examined my family’s situation and came up with the following logic.  Looking back, the amount purchased ended up being about 5 times my family’s income. 

Criteria 1 – Zero’ing out all debt.  The main debt was the new house mortgage, and remaining college and car loans.  My logic was to provide a clean slate and not worry about any existing debt if one parent passed away.  

Criteria 2 – Living on one income.  The scenario I analyzed: Could one parent’s salary be adequate to support all living costs including the kid?  In addition, there should be extra income to save for retirement.  The answer was Yes.  

Criteria 3 – Number of Life Insurance Policies.  Since both my wife’s and my salary were similar, we made the decision to purchase identical life insurance policies for the same amount.

Criteria 4 – Length of Life Insurance Amount.  The 2 policies we looked at were 20 years and 30 years length.  We chose the 20-year policy with the reasoning that the kid will be independent and off to the college when the Term Life policy expires.

Criteria 5 – Term Life vs Permanent Life.  I relied heavily on my parent’s advice at that time to select Term Life as they said Permanent Life was expensive and not necessary.  

Post-Analysis – 7 Years Later

Looking back, the only modification I would have made was purchasing slightly more life insurance for both parents at the start (target 7x times income, instead of 5x income).  

The reasoning for this was that the cost of the kid ended up being way more than I anticipated.  For us, the daycare costs alone were almost $20k/year.  The 20k did not even account for the basics such as food and clothing.  

With this huge cost, the amount of life insurance I purchased would have helped, but potentially not alleviate all the financial strain that I was targeting to protect against.

Adjustments made with 2^nd kid

When the 2^nd kid arrived, there was definitely need to add more life insurance protection due to more expenses.  Instead of purchasing additional Term Life policies, I was able to add Life Insurance through my wife’s and my company.

Both of our companies offer 2x salary for basic life insurance at no cost.  Then there are options to purchase Accidentally Death and Dismemberment (AD&D) on a per-year basis. This was a relatively inexpensive option, which we have both added since then.

Although AD&D and basic life insurance are not the same, this is another layer of protection in case of a parent’s sudden death.  Read PolicyGenius’s Life Insurance vs Accidental Death and Dismemberment (AD&D) article if you are interested knowing the difference.

Including our company benefits, we have about 7x times for basic life insurance and another 3x times family income for AD&D.

Strategy Moving Forward

I am targeting about 15 years left needed for life insurance.  This corresponds to the youngest kid leaving for college and thus being independent.  We will stick with the original 20-year Term Life policies and plan to continue utilizing our company benefits for AD&D and Basic Life Insurance.  

If one parent stops working or if we happen to have a 3^rd kid, we will evaluate purchasing more Term Life insurance at that time.  We will also analyze if we can get by with a smaller amount and fewer year policy.

The reasoning behind this is that our financial situation is much more solid than it was 7 years ago.  Through investing and saving, we have multiple nest eggs and reduced our overall debt.  Due to this, our reliance upon life insurance as the sole financial protection has diminished.

Choosing the Best Life Insurance Type

Recently, I had the chance to examine the different Permanent Life types.  Doing the analysis was hard and gave me a headache because of all the options and variations available. 

In the end, I came to the same end conclusion as my parent’s original advice: Stick to Term Life.

Term Life Explanation

This policy is straightforward and easy to understand.  You need to pay the monthly premiums (it is consistent through the length of term) to get the death benefit (amount of the insurance policy).  

Typically the options you choose are 10, 20 or 30 years and the amount of life insurance you want coverage for.

Permanent Life Overview

The two most common Permanent Life insurance types are called Whole Life and Universal Life.  The main benefit with Permanent Life is that the death benefit is guaranteed and generally there is no set number of years for these policies to expire.

Whole Life Explanation

The highlights:

• As long as the premiums are paid, the life insurance protection continues.  
• A portion of the premiums are invested to build up cash value (Growth is tax-free).  This can be offered as an annual dividend to help pay down your regular premiums.  You can also let the dividends accumulate and grow over time.
• You can take out loans against the accumulated cash value.  Also, if you decide to cancel your policy, this accumulated cash value can be recouped. 

Universal Life Explanation

The highlights:

• This is another policy that guarantees life protection
• Similar to Whole Life, a portion of the premium is invested to build up cash value (Growth is tax-free).
• Universal Life offers the most flexibility allowing you to temporarily stop paying premiums and even take a loan in case of financial hardship.  This loaned amount will be deducted from your overall life insurance benefit and from your accumulated cash value.

Both Whole Life and Universal Life offer additional options called riders at an extra cost.  Think of riders as a way for providing financial support if you end up with a critical or chronic illness, need help for long-term care, etc.

Why you should choose Term Life Insurance

Comparison between Term Life vs Permanent Life

For illustrative purposes, I used the State Farm webpage to generate 3 insurance policies (Term Life, Whole Life, Universal Life).  In order to make it as similar to compare as possible, I chose the same death benefit ($500k) and left out all options for these plans.  

20-Year Term Life Insurance Illustration Comparison (Death Benefit $500k)

	Term Life	Whole Life	Universal Life
Premiums (Monthly/Annual)	$55 / $658	$745 / $8,942	$632 / $7,584
Total Premiums Paid after 20 Years	$13,150	$125,805 (Annual Dividends used to pay down premium)	$151,680
Cash (Surrender) Value Accumulated After 20 Years	0	$131,686 (best case)	$166,292 (best case)

Observation #1: 

The most glaring number that sticks out is how much more expensive the Permanent Life insurance options (nearly 14x and 12x) are over the $55 monthly premium for Term Life insurance.  

Extrapolate the premiums paid over 20 years, and it results in more than $110k paid for Whole Life and $135k for Universal Life.

Observation #2:

As we hope for the best case with no one passing away, we look at the Accumulated Cash (surrender value) that can be recouped at end of 20 years.  

For Term Life, you are left with $0.  For both Whole Life and Universal Life, you will be able to recoup slightly more money than you put in.  This is the best case as stated by State Farm as its dependent upon factors such as market conditions.

You may be thinking that Permanent Life does not look bad especially since you could get back more than what you put in.  However from an investment perspective, there are better ways to get higher returns.

Why Permanent Life is not a good investment

In comparison to the stock market (average gains of 10% annually), Permanent Life is not a good investment.  The primary reasoning is that you are paying a lot of policy expenses and fees that limit your investment gains.

The graph below assumes a person purchased the 20 year Term Life policy for $658 annually to guarantee the $500k death benefit over the 20 years. Then he invests the premiums not spent on Permanent life insurance ($6,900/annual) into the market.

Potential Investment Gains over 20 Years

As you can see, there is a significant difference investing in the market vs letting it build up in the Permanent Life options. Assuming 10% interest, $6,900 annually invested would result in $435k total after 20 years.  Even with a more conservative scenario (7% interest), this results in $303k still nearly double the Universal Life cash accumulated value of $166k.

Not buying permanent life insurance also offers significant flexibility.  You may need to reallocate the $6,900 annually to other places such as paying off high-interest debt, socking away for retirement or saving for other big purchases.  

Read the “Strategies to Manage your Money and Grow your Nest Egg” article as it will give you a prioritized approach to manage your money and ideas to grow your nest egg.

Scenarios where you may want Permanent Life

Most families will be fine with Term Life Insurance.  This is the most cost-effective option.  However, when does it make sense to get a Permanent Life policy?

Reasons to buy Permanent Life:

• Preparing for all possible downside scenarios (death, sickness, disability) and not have your policy expire after certain period.  
• Passing down a guaranteed amount to a spouse or loved ones.
• Already doing well with all your investments and want to use Permanent Life as a way to diversify.

For your specific circumstance, please reach out to a financial advisor for professional advice to help gauge what is best for your family.

Summary

This article provided guidance with everything you need to know about life insurance when you are expecting or have kids. The key points:

1. Get life insurance when you are expecting or have kids.  You want to ensure your love ones will be financially sound if you pass away suddenly.
2. The amount of life insurance needed will vary depending on your family’s situation.  At a minimum, look at zero’ing out all debt, covering for all living expenses, and duration lasting until the kids are out of your care.
3. Add more insurance when needed such as if you have more kids.  Consider alternative means such as benefits through work to supplement Life Insurance.
4. Term Life will likely be the best life insurance type over Permanent Life.  The money saved by choosing Term Life should be used to pay off loans, sock away for retirement or save for other big purchases.

Disclaimer: DadMBA is not a financial advisor.  Do your independent research and rely on your financial advisor and insurance agent for professional advice.  This article’s purpose is to provide general education and awareness on the topic of life insurance.  Your company may or may not offer certain accounts and/or provide benefits as mentioned in this article.  With any investment, you may lose money.

About DadMBA: Through his schooling (he does have a MBA) & more importantly being a Dad, he has provided practical advice to family & friends on finances & other life topics.  He loves helping others thus the creation of DadMBA.