I was in accident. A drunk driver totaled my 1985 BMW 325e; the whole experience was shocking and truly unexpected. My close friend and I were heading south on a highway separated by a low concrete divider when a drunk driver thought it was ok to come across the divider and head westward as we were heading into a ramp to enter Interstate 95. I had no time to react or move as the accident took place in a matter of seconds. In all, we were blindsided by the vehicle and knocked off our path onto a sidewalk and into a tree. Luckily, we were both wearing seatbelts as they saved our lives; had we not, we surely would have been catapulted out of the car as we were driving at 45 mph at the point of impact.
After surviving the accident, I could not help but to think about the potential impact of the loss of me as father would have been to my wife and family. The further I dug in mentally, I began to apply it to Personal Finance; the first thing that came to my mind was my procrastination on finally getting my Living trust finalized, and my term life insurance amounts adjusted to reflect our recent addition. Estate planning is one of those things that many us mean to do but often fail to act on it because we view it as an item of High importance and Low priority. What I am talking about is planning for our inevitable death. We are all mortal beings, and we all have an expiration date, and we don’t always get to know when that expiration date will be. Estate planning is tool used to facilitate the proper distribution of assets and wealth upon the death. The intricacies and variances in estate planning will be covered in another post. For this post, I will focus on the benefits of term-life insurance.
Oftentimes, we don’t think about purchasing life insurance until were older. But, life insurance should be purchased when you’re young for two reasons. The first reason is that purchasing life insurance when your younger allows you to lock in lower rates, and secondly life insurance is used to protect you and family for the period that you are building wealth and supporting your family.
For instance, as you are building a life, paying off consumer debt, paying off the mortgage, saving for retirement, and investing your net worth should be increasing. In the beginning, many do not start out with significant amount of wealth. In fact, from a contemporary perspective, we often start out in life with a negative net worth as result of student loan debt, and consumer debt obtained over the college years. Starting out life and building a family with a lower wealth or even negative wealth level illuminates the risk that you could die prematurely before you can build wealth, and fully support your children and family through adulthood. That is, that a mother or a father may not be able to cover the costs of supporting a family as a result of a premature death (death prior to the children reaching adulthood). Life insurance helps us reduce the aforementioned risk.
Oftentimes, we fall to rules of thumbs when purchasing life insurance (i.e. 10x’s your annual salary), but much more things should be taken into account when purchasing your term life insurance policy. For instance, if you plan to pay the cost of college for your children, you may want to increase your life insurance number to account for the estimated future cost of sending your children to college. Additionally, you may want to factor in the retirement years for your spouse (if you have one) into the amount of life insurance that you purchase.
Although, I’m not a huge fan of rules of thumbs, but I think its best to factor in the age of your youngest child, and cover the period till they arrive at the age of 20. All in all, I think it is best to aim to cover 15x – 20x your annual salary. The latter should provide enough income to pay off a mortgage, invest some of the proceeds for dividend income (to provide a steady monthly income), and invest some of the proceeds into a college fund.
For instance, say your annual income is $70,000; your term life insurance payout assuming 20x your annual income would be $1,400,0000.
$700,000 of the proceeds could be invested in a dividend portfolio paying out 4% per year, which would provide $28,000 a year income.
$300,000 could be used pay of the mortgage.
Without the cost of the monthly mortgage, and additional income from the surviving spouse, the family should be able to shoulder the burden of the loss of income based on the above. On the contrary, if the person had no life insurance the family would be burdened with the cost of the mortgage with no passive income, or savings for college for the children.
In totality, Let’s ensure to protect against the risk of our premature death to help our families to thrive, in the event of our untimely death
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