Life Insurance: Why Do I Need So Much
If you have recently discussed your family’s life insurance needs with a financial planner, you may have left the meeting staggered at the amount of insurance they have recommended and be wondering, “Why do I need so much?” That would be a great question for your financial professional, however, let’s take a hard look at why the need for life insurance is thought of much differently than it was a generation ago.
Have you heard this before, “The insurance will pay off the mortgage and there won’t be anything else to worry about, he/she will be taken care of…”? Though maybe our parents or their parents got away with this, the simple truth is that the modern family needs much more money to sustain their lifestyle, continue to pursue and achieve the goals set forth before the loss, and keep moving the family toward financial freedom.
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The Typical Life Insurance Scenario
To begin, we will examine the common needs of a typical family that may require additional life insurance. Additionally, we need to put some hypothetical dollar value on the costs of achieving things for the remaining members of the family. It will be important to discern that some things will require lump sum payments, others will require a short duration of payments, and yet some expenses never end and will need to be covered year after year.
For the example, let’s consider a family of five living in suburbia somewhere in the U.S. The Father works full time and makes $100,000 per year (and carries the health care) while mom runs a small business out of the home and makes another $30,000. They regularly save for retirement and rainy days, as well as saving $10,000 for each kid’s college expenses. The couple has three children, ages 10, 13, and 15, all of whom plan to attend college. The 15 year old will likely secure a half ride athletic scholarship – so we’ll include this detail in our planning. The family lives in a $400,000 house and still owes $200,000 on a first mortgage that will be paid off in more than ten years.
And Now the Unthinkable
Suddenly, the father is in an accident and passes away. Let’s take a detailed look at what they need now, over the coming years, and for further down the road. Let’s also assume that the family doesn’t want to change their lifestyle, plans, or dreams due to the loss. Alright, here is what is lost:
- 15+ years of future income and raises – estimated value $1,500,000
- Future retirement savings to 401(k) – estimated value $250,000
- Health coverage (employer portion) for family – estimated value $1000/month = $300,000
Now, let’s look at some of the other ongoing expenses that will be required if the family remains in the house, schools, cars, and lifestyles they had before. These expenses will remain:
- Mortgage payment (loan only) - $1600 per month
- Property taxes and homeowners insurance - $400 per month
- Utilities, cell phones, and other household expenses - $500 per month
- Food, gas, allowances - $500 per month
- 2 car payments and insurance (not including kids) - $1000 per month
So, the ongoing expenses for the household are $4000 per month! Even if we pay the mortgage off with the life insurance proceeds we still have $2400 per month when we include the property taxes and insurance that will remain. Won’t these expenses remain for as long as the family remains in the house? Isn’t it more likely that these expenses will rise over time as kids drive, costs rise, and inflation comes into play? Yes… and Yes.
Thinking Long-term
Now, let’s talk about college for the kids. This scenario may be common among families with many children: The oldest will enter college in three years, at which time there will be about eight or ten years with two kids in college each year! If we assume an average college cost of $20,000 per year now, we had better assume a bit more for the younger two. In this example we’ll go with $25,000 per year for the middle and $30,000 per year for the youngest child. Here’s the breakdown:
- Oldest - $80,000 total minus half ride scholarship = $40,000
- Middle - $100,000 total for four years of school = $100,000
- Youngest - $120,000 total for four years = $120,000
That’s a grand total of $260,000 for college expenses! Now, they were diligent and saved $30,000 so the remaining expense is only $230,000…
What This Means for Your Policy
It is fair to say that the family will not be able to maintain all of these expenses simply on the mortgage being paid off and the mother continuing to work. With a basic breakdown we have uncovered $2,235,000 of total losses and expenses. Additionally, we have identified an ongoing need of around $4000 per month, of which some will go away after some years but others will rise as the years pass.
The bottom line is that there is a clear need for substantially more money than the funds to pay the mortgage to zero. Further, it is important to have an open discussion before a crisis. Tell your financial planner what you want for the surviving spouse and kids. Be realistic about things like whether or not the spouse will need time away from business or work to comfort the children or even return work at all. These are the important questions that need to be discussed so the appropriate plans can be set in motion.
In conclusion, the real number for an amount of insurance for this example family is probably not as high as $3,000,000 but also not as low as the mortgage balance. The high number would maximize comfort, but the truth is that it may be expensive. Your financial planner can come up with an exact amount based on your situation, with detailed plans on paying debt, investing the remaining assets for growth and income, as well as covering all the dreams and plans your family will want to achieve regardless of loss. The point is it’s better to be well prepared. An unfortunate fact is that most families in the United States are underinsured.
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