Yesterday I was chatting to a friend of mine on the phone; many friends gossip or make trivial arrangements. But I am a personal finance blogger and had just looked at out budgeting spreadsheet…so I mentioned how proud I am that couple of years ago managed to get higher insurance cover (rather high, actually) at much lower price. My bragging was caught short when my friend (who incidentally is a professor of accounting) said:
‘Why do you need all this life insurance? I don’t have any – it is waste of money.’
How our conversation continued is a private matter. What is important is that this made me think: death is not an uncertainty. If anything it is one of the few certainties in life. When deciding to take out life insurance, however, the uncertainty we are hedging against is the timing of our demise rather than the event itself. This timing would be a disaster only when our circumstances are such that we are likely to leave behind financial frailty; and do notice that I am not saying ‘mess’ but frailty.
Identifying the points of your financial frailty will help you not only whether you need life insurance but also would allow you to calculate the level appropriate for your situation. Let me use as example the points that I used to decide how much life insurance I will buy.
You position as earner
This is absolutely vital for your decision. If you are the primary earner in the family you need insurance; and probably quite a lot of it. Irrespective of whether you have children or not, it is your duty to make sure that your partner has the means necessary to maintain a decent life style.
In my case, I have been the primary earner for some time now – although John also earns well, most of it is fairly uncertain coming from contracts. Check!
This is a bit tricky one. On the one hand, the older you are the less insurance you can afford – it is probably not that good for the ego but after a certain age the probability of decease and death increases so much that the cost of insurance becomes prohibitive. On the other hand, you still may have dependents that rely on your income and case. In such situation it is probably better to save or invest a similar amount.
The age of your partner also plays – having an older partner makes it prudent to buy generous levels of life insurance. After all, being younger you should expect to hit a time when you support your partner.
There is no doubt, no hesitation about it: if you have children who are not in their late teens yet take out life insurance – enough to get them through school, university and help them have a half decent start in life.#
Mortgage and other liabilities
If you have mortgage and other liabilities it is wise to take out life insurance that matches or exceeds their value.
…whether you need to take separate life insurance or you have some through your pension. Do the calculations carefully – you may already have life insurance through your pension (I do) but it may not be enough.
This brings me to the matter of how much life insurance is enough – being over insured is not as serious transgression as not being insured but still…
How much life insurance is enough?
To decide how much life insurance to carry, I did the following:
- Calculated all our liabilities
- Calculated how much John will need to live on and raise our son
- Checked the conditions of my pension
The amount of life insurance I have is
(Total liabilities + £100,000/$160,000) – insurance through pension
My calculations show that this, and the pension that John and our son will receive were something to happen will be more than enough.
We used the same logic to calculate how much insurance John will carry.
How do you decide?