By May 4, 2011

Life Insurance: Financial Protection for the Preparedness Minded

People who believe in being prepared often fall into a trap. We tend to perceive “being prepared” in terms of things we own, or things we know. Water purifiers, hand-crank radios, medical kits, firearms. Orienteering, canning, first aid, civilian CQB. Maybe we fixate on these things because researching a buying a new gadget or spending a few days training is enjoyable.

However, there is another pillar to being prepared, and that’s how you handle what happens after you die.

Three and a half years ago I wrote about the importance of establishing a living will and medical directive. Spending a few hours with a lawyer may seem expensive and nerve-wracking now. However, it’s a lot less expensive and painful for you to sit down while you are still healthy and lay everything out than when something goes down and people argue about your physical condition or estate.

The other side of the “you kicked the bucket” preparedness is life insurance. I always had pretty good life insurance through my past employers. My current job offers really terrible life insurance (only up to $50,000!), and that is probably not enough insurance for anyone. So for the first time in my career I had to look into buying my own life insurance.

Yes, life insurance can be confusing. There is a lot to learn. Yes, you have to speak with someone who will try to sell you a lot of stuff you may not need. Yes, there will be a physical involved. However, the same things apply to many badass survival gadgets and training you already have, so don’t get nervous about shopping for life insurance. Here’s some basic information and my experience to get you started.

What is life insurance?

I’ll state up front that I like to keep things simple, especially when I am learning about something for the first time, or buying a company for the first time. So all of my decision making was around my loved ones receiving money after I died. A lot — I mean a lot of insurance marketing materials are centered around using certain types of life insurance policies while you’re alive by borrowing against it, or using life insurance as an “investment vehicle.” I stayed away from those goals and all of those products, because I wanted to keep it simple. To me, life insurance should pay out a sum of money when I die. Life insurance + living will = a means to provide for my loved ones and a plan by which to do so.

Unless you are really savvy with investment products or really trust your financial advisor I would keep your life insurance needs simple.

What is life insurance used for?

This is where your individual definition of preparedness will really kick in. For many many years life insurance was sold “to get to zero.” What that meant was people added up their current debts and bought enough life insurance to cover those debts. If you owe $250,000 on your house, have $30,000 in car loans, $20,000 in school loans, $15,000 in credit card debt, and want to pay $10,000 of your funeral costs you’re looking at $325,000 in coverage.

Getting to zero provides the more basic level of protection for your loved ones. It just pays off the stuff you already owe and starts everyone off on a clean slate. This is a good goal, and may people are satisfied with getting back to zero. However, it doesn’t allow for the future. Here are some other things people commonly buy additional coverage for:

  • Sending kids to college. Pretty self-explanatory as a goal, but how much you should save can be complicated given rising education costs and inflation. There are some calculators to help you with this.
  • Providing income replacement for your survivors so that they can maintain their current quality of life (or improve it). Life insurance sales people will recommend that you multiply your current income by 5 – 20 and that’s what you should shoot for. Deciding how much to purchase here will depend on your current standard of living and the disparity between your income and that of your loved one. Your multiplier may need to be higher if you provide the majority of the household income.
  • Donating to charity. You may belong to a church, or want to leave money to a foundation of some kind.
  • Provide down payments for homes. A buddy of mine has a directive in his will that his kids will get money for the express purpose of buying a home. His executor will release the funds when the kids are ready to settle down. His insurance policy provides $50,000 in coverage for each child. So again, there’s the combination of having the money, and also having the direction on how the money will be used.
  • “Do something” money. You might want to send your loved ones on an awesome trip when you die. Sort of like an apology for all the times you bored them with information about the merits of the slingshot slide release vs using the slide release lever. You might want to provide money for an attorney so that your loved ones can re-open a struggle with an old enemy, or prepare them for a battle for your estate. It doesn’t matter what that “something” is, you may want to set aside some additional funds to make it happen.

How much life insurance do I need?

That’s the million dollar question, isn’t it (often literally)? I mentioned getting back to zero earlier. That’s a good start. Individual needs will vary wildly from case to case, but here are some general rules of thumb:

  • How much money do you already have saved up? If you have a nice 401k, some cash savings, and some investments you may not need a lot of life insurance. Knowing what you want to do with your estate is an important first step in knowing how much insurance you need. If you want to provide a million dollars in preparedness but your 401k is only worth $100,000 and you only have $7000 in the bank then you have some work to do.
  • How in debt are you? Part of “financial preparedness” is being as debt-free as possible. You may need more insurance depending on your body of debt and your survivors’s ability to repay it. Leaving your kids behind with a mortgage on an upside-down house and a bunch of bad debt is not good financial preparedness.
  • Who else can provide income? If you’re single this doesn’t apply to you, but if you are in a relationship then the difference between your earning potential and that of your loved ones comes into play here.
  • Consider buying multiple, shorter term policies to get over “life humps.” A lot of people get insurance to pay for an “event” like getting kids into school. So they buy a big ass insurance policy and pay it for a term of 20 or 30 years. However, the event is long over before they reach a statistically probable death age. Some people buy a base level policy and then add shorter term policies (like a 10 year policy) to cover the period of time leading up to the event.

    For example, let’s say you want to send two kids to school, one in five years and one in thirteen. The older child will probably need $80,000 – $200,000, and the younger child may need $200,000 – $500,000 due to rising costs and inflation. So to be safe, you get $700,000 worth of coverage and tack it onto your 30-year term policy. While having extra money is nice, both of your kids will be past that saving event before your policy is even halfway done.

    You may want to consider buying a policy to cover a base level of needs required for the full length of the term. What expenses or goals will apply from the first day your policy is issued to the very last day, perhaps 30 years later? That’s your base amount. Event-driven plans can be added as a supplement. In our college saving example, you may want to get a less expensive smaller, shorter-term policy. Perhaps you split the difference between the kids’ education costs and get $700,000 in coverage. Depending on your age, this may be a significant savings — at my age it triples the cost of my monthly payment to shoehorn in that extra coverage. In my case, I’d save at least $30/month x 20 years = $9000.

  • Types of Life Insurance

    There are two major types of life insurance being sold in America right now: term insurance and universal insurance. There is also whole life insurance, but its popularity is waning with the top carriers.

    Term life insurance: this is what most people think of when they think about life insurance. Basically you buy a fixed amount of coverage for a set period of years. At the end of that term your coverage ends. In my case, my core policy is on a 30 year term. Your annual price (called a premium) should stay the same during the duration of your policy. Some carriers allow you to extend your coverage after the term limit is over, but it is SUPER EXPENSIVE. In my case, my annual premium will jump from about $950 a year to over $22,000 a year!

    Universal life insurance: this type of insurance is being pushed very heavily by insurance carriers these days. They tout benefits like being able to take loans out against your policy, and being able to vary your premium as your needs change. You can pay a very low mandatory premium which just keeps the policy in force on an annual basis, a “target” premium which may be enough to keep the policy going indefinitely, or even more to increase the amount of money in your insurance benefit pool. Some insurance sales agents will market this coverage as a “savings account bundled with life insurance” or an “alternative investment vehicle.”

    Be careful about this type of insurance. It’s a lot more complicated than term, and you may be misled into thinking you are getting more for less. I recommend you read this article about underfunded universal life policies on Badfaithinsurance.org for more information. Talk with other universal life policy holders before you commit to buying, and do your own research before contacting an insurance agent or broker.

    I like to keep things simple, and I purchased a 30 year term policy. I bought a longer term because by the time my term expires it will be very expensive to buy another policy. I wanted to get coverage far enough into the future that I wouldn’t need to buy any more life insurance, either due to having a decent financial portfolio by then, or not having a need for an insurance payout, or both. The term of your policy should be based on your current age and your financial needs and goals at the end of that term.

    How do you buy life insurance?

    If your only experience buying insurance is automobile insurance, buying life is going to be vastly different. You won’t be able to buy life insurance online, and most companies won’t allow you to get quotes online. Most life insurance products are heavily regulated, and these regulations vary from state to state. Some states won’t even allow carriers to show you things like coverage calculators, rough quote estimators, or signup forms for more information.

    You’ll have to get quotes from an agent or a broker. An agent typically sells just a few brands of insurance. A broker will sell many types. In very, very general terms, an agent will spend more time with you to discern your needs, whereas a broker just wants to sell you a policy. If you already know what type of insurance you want, how much you want, and what you’re willing to pay, a broker may be perfect for you. If you need some guidance or have questions, it’s better for you to see an agent.

    There are several steps to getting life insurance. There is an application process, usually handled over the phone. The broker or agent will get your contact information and ask you some basic health and medical questions. Be prepared to answer questions about any medication you take, any past or current conditions, and about deceased family members. If you smoke and are out of shape, you will pay more for life insurance. Sometimes it’s a lot more. At the end of this period the agent/broker should be able to tell you if you stand a good chance of being insured, and some general quotes for coverage amount and duration. However, these are not binding decisions and numbers; it’s up to the actual insurance carrier to decide if they want you as a customer or not.

    Assuming you didn’t scrub out, the next step will be a physical exam with a nurse. My broker offered to send a nurse to my home or office. They will take blood and a urine sample and you will be required to fast. For these reasons I asked the nurse to come to my home. The nurse asked me additional medical questions — there are many, many pre-existing conditions they will ask you about during this phase. The appointment was easy to set up, and the actual procedure took about 30 minutes start to finish.

    If your medical check comes back okay you will enter the next phase, where the insurance carrier attempts to verify your medical history claims. They may contact you to ask clarifying questions (they did in my case about a skin condition I had seven or eight years ago). Except questions about any prescription. Some carriers are pickier than others, but if you have a long and varied medical history you may want to wear something comfy and settle in for an interview.

    After that process is complete the insurance company will ask you for money. You can typically pay annually, semi-annually, quarterly, or monthly. The amount of your premium may go up as you pay more frequently. I went with a quarterly payment schedule, as the difference was only about $20 a year. Your circumstances may vary.

    Even if the insurance company is willing to cover you, your policy will not be in effect until they have a payment. Of course, you have to keep paying your premiums for your policy to stay in force. Most carriers accept credit cards for payment, and my policy is set up as an electronic funds transfer (EFT) right from my bank.

    Last thoughts

    I didn’t cover a lot of stuff here, like “riders,” optional things you can buy for your insurance policy. I strongly advise you to do as much research as possible online about life insurance before talking to a financial professional. Sometimes you get lucky and get a nicer agent who wants to sell you the product that fits you best. Othertimes you get an agent that is really good at selling one product and will try to cram it down everyone’s throat in a “one size fits all” approach. Regardless, these people earn their livelihood by selling you insurance. If you don’t come prepared with your own knowledge then you may wind up buying something that you don’t really need, or too much coverage, or buying for too long of a term.

    Life insurance is less expensive the younger you are. This is based on statistics (and common sense). In general, people are less likely to die if they are younger. As you get older, your chances of dying increase. That’s just how shit goes. I recommend that you determine a target age wherein you will not require life insurance (or as much) to provide for your loved ones. Subtract your current age from that target age. That’s the longest term you want to buy. Buy the least expensive term that fits your coverage needs. For example:

    I’m 35. My target age is 65. If I don’t have my financial situation together by then … well let’s just say I piloted the failboat into an iceberg somewhere. So I was a good candidate for a 30 year term. Because I never smoked, don’t drink, and am in good shape I got the best rate possible for an unmarried male. I bought a seven figure policy, and I spend more per month on coffee than I do my life insurance. It’s cheap, if you live right and buy appropriately.

    If you’re 45, then you may want to buy a 20 year term. Buying a 30 year term will not only be more expensive, but it will probably extend beyond the time period in which you actually need a financial safety net to pay off your debts and provide for loved ones.

    If you’re 25, you may want to buy a 30 year term. Consider a smaller, secondary policy to cover you during expected “events,” like children and preparing them for college, etc. You may also want to buy a smaller 30 year term policy and then bolt on a larger policy when you are in your 30s or 40s and can afford more insurance.

    Disclaimer I used to work for an insurance carrier that sold life insurance and many other insurance products. I wound up buying one of their life insurance products, but only after I stopped being an employee there (their employee benefits were great, my current employer’s are not as good). While I endorse their product, you may find a better fit with another carrier or another type of life insurance product. I received no compensation for writing this article.

    Also, I am not an insurance sales professional, nor should this article be construed as professional advice on insurance, estate planning, or personal finance. I’ve done my best to document my own, personal thought process during my own, personal decision to buy life insurance that fit my needs. Your needs and risks will vary, and what I did may not be what you should do. Do your own research, and talk to a professional if you have questions.

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2 Comments on "Life Insurance: Financial Protection for the Preparedness Minded"

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  1. Jenner says:

    Another thing to consider is not putting off the decision to buy. I bought my term policy 20 years ago when I was in my 20s and in excellent health. A few years later I was widowed and went into a depression…. hence a “history of depression”. Four years ago I fell down the cellar stairs and suffered injuries that had me spend some time out of work on disability. Both events, I found out last year, pretty much rule out my being able to buy new or increase my life insurance at a reasonable price, if at all. Thankfully I still have what I got then. It isn’t enough, but if I had waited I’d have nothing. I’m very lucky I was smart enough not to put it off. Few people in their 20s buy life insurance, that’s exactly when they should.

  2. cymwyd says:

    Wonderful article. I’ll be using this as a basis for reviewing our current policies with the Pirate King – who insists that getting to zero is all we need.

    A few points that you might want to consider in a different post. These relate to planning, but not life insurance. They might be covered in your general preparedness post; it’s been a while.

    Somewhere, you need to document things like: where you keep important documents, and where to find the key for the safety deposit box they are in; passwords for accounts; bill payment schedule; name/POC info for your attorney, accountant, PCP; etc. The audience for this document is your POA or executor, and will instruct them on where to find the paperwork and how to keep the lights on.

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