Last month, one of my partners left the office a little early to arrange for life insurance. She wasn’t quite sure how much she needed, so she had decided to use the rule of thumb of 8 to 10 times her annual salary.
We talked about this a little, and I realize this is a somewhat silly rule of thumb. Sort of like saying you need to save 12x your salary before you retire.
The issue is that your salary doesn’t necessarily correlate very well with either your family’s financial needs or your retirement spending.
The professional couple without children
Consider a married couple, both professionals making good money. Their salaries are equal. They have no debt except for the mortgage on the house they bought last year. They easily pay their bills, including for a house keeper who cleans house and runs a few errands once a week. There is plenty of money left over, and they save about 50% of their income.
If one spouse dies, as long as the mortgage can be paid off, the other can easily support himself.
So how much insurance does this physician need?
Really, she needs only enough to pay off the mortgage. Maybe a little more so her spouse can take off work to grieve and sort through her belongings. Certainly, unless they bought way too expensive a house, they don’t need 10x her salary.
the breadwinner with children
Now consider a different couple.
We have a clear breadwinner, and either a stay at home spouse, or one who makes much less (enough to put away money for retirement and pay some of the smaller bills). They have 3 small children. They have either a nanny or a few babysitters to help with childcare. They bought a house in a very high cost of living area, and their mortgage balance is huge. They still have student loans.
That breadwinner is supporting 4 other people plus the nanny/babysitters. If she dies, she wants to leave enough insurance money to:
- Pay off the mortgage.
- Pay off the student debt (if it won’t be discharged with her death).
- Provide for 1-2 decades of living expenses for the spouse and children. She doesn’t want the family to suffer more by having to give up their home and lifestyle after losing their beloved parent/spouse.
- Either replace the spouse’s salary and benefits so he can stay home and care for the family, or to pay for child care and home maintenance while the spouse continues to work.
- Consider leaving enough that the spouse can invest for retirement (as though both were still living and saving in their 401(k) or 403(b) plans).
- Help with the children’s higher education, if they are going to go to college.
If the unfortunate event occurs early enough, the total needed to manage all this may certainly be 10x the breadwinner’s salary. It might even be more than that.
what will your dependents need?
Deciding how much life insurance to get really depends on what financial needs your dependents will have, and what you feel insurance should cover for them.
Paying off debts, like school loans, car loans, mortgages, all seem pretty reasonable.
You might want to arrange for children to have opportunities such as summer camps, music lessons and Little League fees, college tuition. If you were planning on providing it while living, leaving money for this seems fair.
Then there is the matter of general financial support. If you were going to be paying for utilities, groceries, clothing, and the occasional vacation, then get enough insurance coverage to let them do this even though you are gone. Deciding how long to provide this for can be challenging–is your spouse on his own once the last kid turns 18? Do you leave a little more behind so he can live out his older years in greater comfort? Are you going to leave enough for a new car at age 18, designer clothes, and full tuition at Harvard for each kid? Or are you thinking that a used beater and Goodwill clothes were good enough for you, you don’t want the kids to be spoiled just because you died when they were little. And public university is just fine.
All of this requires a little more thought than getting coverage for a multiple of your salary. Though I suppose that’s a good enough place to start if you are in a hurry
Quick quiz: how much life insurance does a single childless physician need, if his parents are retired comfortably and his siblings are high earning professionals?
Answer: if he’s not supporting anyone, no one needs his money if he dies tomorrow. He doesn’t need to get life insurance. (One can argue that he might want to preserve insurability in case he gets a bad disease. By the time he gets married and has dependent children, he might not be able to get life insurance).