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Insights Into Life Insurance from an Actuary
One of my closest friends in the world completed a Ph.D. in mathematics recently and became an actuary for a very large life insurance company. I had lunch with him recently just to catch up on things and we spent about 10 minutes talking about life insurance itself.
He basically told me that if I’m a financially sound person, I’m throwing my money away on life insurance unless I meet a few strict criteria: young, a relatively low net worth, and young children. This kind of blew me away considering he’s in the life insurance business, but when he broke it down for me, it made a lot of sense.
Note that the advice that follows is based on a conversation between friends and shouldn’t be viewed as professional advice, and you shouldn’t just follow it blindly without doing your own research (like on this site, here), but it is quite interesting and worth sharing.
First of all, unless you are a financial train wreck, you should never buy anything but term life insurance. Insurance as an investment is a great investment for the insurance company but a terrible one for you. If you want insurance, get insurance; if you want to invest, buy an investment. Don’t mix the two – it’s akin to buying a box of bad cereal to get the cheap plastic toy inside. Why not just save a buck and get a better box of cereal, then spend the buck to get a better toy? If you’re convinced you want to use your insurance as an investment tool, you must understand how to do it. You can find TSD posts on: cash-value, life insurance settling, and building and borrowing cash from your life insurance policy.
Second, if you have no dependents and no spouse, don’t buy life insurance. Ever. Don’t let a salesman talk you into it.
Next, the more net worth you have, the less insurance you need. This means that before you start thinking about life insurance, know what your net worth is. This is an important number for figuring out how much net worth you’re going to need.
After that, think about your family’s needs carefully. Look at how many people are in your household (spouse plus dependent children) and multiply that by five, or maybe a bit more if your children are very young – this number is the number of years worth of your salary that would be needed to support each person in your house should you pass away. He suggested multiplying it by six in my situation, but I wanted plenty of security for my kids, so I used eight. I then multiply it by the number of people in the household, four. That gives me 32. This is the number of “salary years” that I should leave behind.
Then, multiply your calculated “salary years” by your current salary (or reasonably expected salary in a few years) to see how much total worth you should leave behind. Let’s say I make $50,000 a year; multiplied by 32, that means I need to leave behind $1.6 million. Ouch. That’s a lot.
However, one should subtract from that their net worth. I would make a little dent in that number, but not a big one, leaving me with still quite a sizeable policy. If I went with a lower multiplier (say, my friend’s recommended 6), I could reduce the policy quite a bit.
Once you have your magic number, get a relatively short term life insurance policy for that amount, usually long enough to last until your children have left the nest. For my example here, that means I would get a 20-year term life insurance policy for $1 to $1.5 million. The premiums on that would be $600 to $800 a year, or $50 to $65 a month. He suggests doing this so that one can potentially get a better rate with a 20-year policy instead of a 10-year one, but notes that policies that extend beyond when children leave the nest are a fool’s game.
When your policy expires, don’t renew it immediately – recalculate. Let’s say that in 20 years, my children have left the nest, leaving my wife and I home alone together. We’ve built up some serious savings, our home is paid for, and thus our net worth is in pretty good shape. I sit down and recalculate and discover that in fact my net worth now exceeds 10 times my salary (five times the people in household, which would be two), so I just don’t bother with life insurance again, leaving me with $50 a month more to enjoy or invest.