One of the first questions I help my clients answer is how much life insurance they actually need.
So many pop culture financial “experts” will give you the same, generic answer to this critical question. But I don’t believe this answer is as black-and-white as they lead you to believe.
My goal is to insure your life rather than rely on a one-size-fits-all formula.
The typical starting point
On the surface, the advice you can readily find on the Internet seems pretty sound and easy to follow.
Trendy financial planners say that the amount of life insurance should be between 6 and 10 times your annual salary. Most advisors settle on 10 times your salary.
So look at your annual income, multiply it by 10, and that’s how much insurance you need. If you make $100,000 a year, you are typically advised to insure yourself for $1 million.
To figure out how that logic is supposed to play out, subtract your income tax and other withholdings from your annual income to figure out what you actually take home each year. In most states, if you’re starting with $100,000, you’re left with an average of $70,000 after federal and state taxes.
You’d need to replace that annual amount to help your dependents maintain their current lifestyle should you die suddenly.
Some advisors say to take 6% of your gross income, add 1% for each dependent, and that’s how much you should spend each year on insurance.
While all of this is a fine starting point, life typically is far too complex for standard formulas.
Why context is important
I understand the need for generalized advice when dealing with the masses. However, my clients represent a wide array of financial situations, family makeups, and personalities.
There just isn’t a one-size-fits-all insurance plan.
One of my favorite parts of my job is getting to know my clients. It’s easy (and personally advantageous) for financial advisers to sell the biggest and best insurance packages.
I’m not comfortable doing that. My goal is to understand your full financial picture and tailor your insurance to your needs.
Meet Alison: A dentist with small children
To illustrate my point, let’s look at some practical examples, starting with my (illustrative) friend Dr. Alison.
Alison makes about $160,000 as a dentist, so most advisors would encourage her to take out between $960,000 and $1.6 million in life insurance.
Alison is still fairly young, it’s pretty early in her career, and she feels optimistic and confident about her future. She has many other expenses she’s focused on. So while she knows she needs life insurance, she feels confident that she won’t need it for a long time.
Her first thought is to stick with the standard $1 million policy, going for the lower end of the suggested range. She figured she could increase that amount later, after she feels more financially flexible.
A million dollars sounds like a ton of money, so she believes it would be more than enough to help her family if something tragic were to happen to her.
However, Alison also has over $300,000 in student loan debt from dental school. She also has three young children, and is the primary breadwinner of her family. She and husband just bought their first house.
So if she were to suddenly die, her husband, Mike, is left dealing with funeral expenses and scrambling to find a job — after being a stay-at-home dad for the past 7 years.
His new job doesn’t compare to Alison’s high-paying job, making it much harder to cover their regular bills and lifestyle. He struggles to find daycare and after-school programs for their young kids, which become new expenses.
Suddenly, the new house is no longer affordable. How is Mike going to afford raising the kids for the next 17 years, never mind pay for their college tuition?
Don’t forget the $300,000 worth of student loans. While some of the debt could be discharged – especially any federal loans – Mike could remain on the hook for the remaining private loans.
Plus, if the couple had any joint credit cards, Mike is now the one solely responsible for those.
That $1 million seems much smaller than it once did.
Would it still be enough? Maybe. But Mike and Alison’s children, their new house, and Alison’s status as the sole breadwinner are special circumstances that require a more in-depth discussion.
Meet Carlos: A plumber worried about his mom
In contrast, Carlos is a plumber who makes $55,000 a year. The 6 to 10% suggested range for him would be between $330,000 and $550,000.
Carlos is a cautious man who always plans for the worst. His first instinct was to take out a $1 million life insurance plan.
But unlike Alison, Carlos is middle aged and single. He doesn’t have any kids. He paid off his $3,000 of trade school expenses within his first year working in the field. He bought a modest house when he was younger, and he isn’t far from paying it off.
Carlos has always been wary of credit cards, so he has one for emergencies – like the time his transmission went out the same month his hernia surgery bills came due. However, he pays them off as fast as he can and maintains a zero balance until the next emergency hits.
I asked him why he wanted a full $1 million of life insurance.
Carlos confided in me that his mother is approaching 75. He is her only child. While she is active and independent now, it won’t be long before she moves in with Carlos, making him solely responsible for her care.
While Carlos learned to be financially cautious from his mother, she was a single mother who worked housekeeping and service jobs. These were hard on her body, and they didn’t allow for huge retirement savings.
Carlos worries that if something were to happen to him, his mother would be alone in the world without any financial resources or any other family to help her.
Instead of selling Carlos a costly policy that would likely go to waste, I sat down with him to ensure his mother would be well cared for without relying on her son’s life insurance.
Your peace of mind
Your situation is unique too. Let’s sit down to examine your family’s circumstances. We’ll make sure your family is protected — no matter what happens.
Make an appointment with me today!
