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Financial planning for financial independence

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How Much Life Insurance Do I Need?

When it comes to life insurance, Americans are underinsured as a whole.  This should come as no surprise, since it is well documented about how little we like to save and how much debt we like to take on as a population.  It's the American way!  But all joking aside, not having enough life insurance is not harming you, but worse, it's being negligent to those you love.  Leaving behind a financial strain on those close to you (in addition to the numbing grief) is something most would like to avoid at all costs.

So this begs the question of "how much life insurance do you really need?"  While the question may sound very simplistic in form, as with many things in life, the answer is not going to flow off the tongue (or keyboard) quite as easily as one might hope.  This is because everyone's situation is different.  However, we can use some general rules of thumb to help evaluate how close you are to where you need to be.  Let's start with the first of three questions you need to ask yourself.

Do I Need Life Insurance?

Why is life insurance needed?  Primarily it is used to cover the big D's in life:  Debts and Dependents.  Do you have one or both?  If so, life insurance could be warranted so that you don't leave a financial burden behind (likely not the legacy you want to be remembered for!).  Move along to the next question to find out if you have sufficient coverage.  If you have no debts or dependents at the moment, life insurance is likely not a necessity, but make sure to readdress if/when your situation does evolve.

How Much Life Insurance Do I Need?

For this section, let's break out the two primary areas of concern that warrant financial protection.  You should tally an amount for each category, then total them together.

Debts:  Calculate how much debt you have outstanding present day (mortgages, personal loans, credit cards, etc.), then tack on an extra $25k to cover future miscellaneous expenses (it's not an uplifting convo, but estate and funeral costs are a thing).

Debt + $25k

Dependents:  Is anyone else in your life dependent on your financial support (spouse, children, relatives, etc.)?  If so, calculate how much financial support you provide them per month, in actual dollars.  Multiply this number by 12 to get an annual amount, then multiply that number by 25.

Annual Financial Support x 25

Now add up the two figures you have from each section.  Do you have enough in individual assets/investments (not including shared items like your family home or car) to cover this number?  If so, then congratulations because you are likely self-insured by your net worth.  If not (which is the majority of us), you need life insurance to make up for the difference.

Debts/Dependents Total - Assets/Investments = Life Insurance Needed

So, how much life insurance coverage do you currently have?  If you find yourself significantly underinsured from where you need to be, I encourage you to take steps today to close that gap!

Bonus Recommendations:  1) I suggest that you do not include your work life policy into your current life insurance coverage amount unless it's portable upon separation (usually is not).  With the way we rotate jobs today, chances are you won't be at the same employer for the entirety of your career.  2) If you would like to provide for future large potential expenditures for your family (college, cars, trips, etc.), I suggest adding some cushion to the "Dependents" number you calculated above (maybe even an extra 20%).

What Kind of Life Insurance Do I Need?

This guy sleeps well because he knows that his pops has adequate life insurance coverage

When it comes to life insurance, make sure to keep things basic.  You don't need to overpay for a flashy policy.  Insurance is not an investment vehicle; rather, it's a protection and wealth preservation product.  Anyone looking to sell you a hybrid of the two (insurance & investments combined) is likely viewing you as their next large commission check.  A term life insurance policy is all most people need for the following reasons:  1) your major debts should be paid down over time, 2) your dependents will usually grow to become financially independent, and 3) your net worth should continue to expand.  Term life insurance is a bridge that will get you to a future point of financial security, and is the most affordable and pure of all the life insurance vehicles.  Most term life insurance policies can range anywhere from 10-30 years, so pick a policy that will get you to that point down the road where you will be free of having to worry about the two D's.

You can get a quick and easy term life insurance estimate from a site I love called Quotacy.  Check it out.  Chances are you will be surprised about how affordable coverage can be.

Now, go get insured!  Your family could be left with a major financial burden if you don't.

Bonus Note:  There are certain situations where whole and/or universal life insurance policies can make sense (a topic for another day).  But for most, term life is all that is warranted.


Footnote to the article:  The calculation used under the "How Much Life Insurance Do I Need?" section above is meant to be a simple, back of the envelope estimate on life insurance needs.  Everyone's situation will vary in some way, shape or form.  For a detailed analysis, one should seek to find a qualified financial professional who can provide personalized advice.