Tuesday, May 27, 1997
Your Insurance or
Your Life
or
Paying Off the Grim Reaper
by
by TMF Runkle
In two previous Fribbles, I've written some pretty negative things about whole life insurance. However, I didn't cover the need to carry life insurance. Ironically, the one thing that we probably fear the most will definitely happen to us. We will all die, either one at a time, or all at once in some cataclysm that the people knocking on my door Sunday morning claim. Unfortunately, in addition to fulfilling our greatest fear, our death may cause quite a bit of hardship on our loved ones.
If we live to be old, our children should be self-sufficient by the time we die. Our spouses hopefully will be covered by pensions and investments. The greatest problem occurs if we die young. If your spouse doesn't work, the problem will be entering the workforce again. Finding a job will be difficult, and when a job is found, it isn't likely to pay that well. If your spouse already works, the second income is lost. Your former lifestyle will have to be carried by one salary, not two. If you don't work, your spouse will have to pay someone to watch the children, and for many other things you do that space doesn't allow me to list here. In any case, it will be one person transporting the children to daycare, doing housework, paying bills, and working. Being a single parent is not easy.
Unfortunately, the expenses your loved ones encounter when you die don't go down as your children grow up. College expenses are horrendous, and often grown children need financial help once they leave home. However, the period the funds are needed gets shorter and shorter. Since we've established that you need to leave a lot of money when you die, how much is enough?
The best way to figure how much insurance you need is the Present Value formula available in your trusty spreadsheet (usually called PV). The Present Value gives you how much you need to obtain fixed payments for a certain number of periods given a rate of expected return. Here's an example: assume you want to have regular payments of $3,000 a month for the next 20 years. Suppose you can get an annual return of 8% through a combination of stocks and short-term investments like CDs and such. How much do you need to set aside? $358,662.88 to be exact. Oh, I suppose you could get away with $358,660.
Obviously, if you die young, you're going to need to leave a lot to your widow or widower, won't you? What happens if we shorten the period? Let's say you are planning on dying when your youngest child is 18, and you want to leave $6,000 a month for the next five years, to cover college costs, living etc. After that, all the kids are on their own. How much do you need? $295,910.60. A lot less considering you are leaving double the amount in monthly payments.
Where am I going in this grim discussion? Your needs for insurance as you grow older are much less than when you are younger. However, you need a LOT of insurance when you are young. Otherwise, your death will cause a lot of hardship.
Now it's time to give you some things to cheer you up a bit. It isn't that expensive to have a lot of insurance when you are younger. When insurance companies write policies, they are betting you won't die. Since the odds are in their favor when you are young, you can buy a term life policy for quite a bit without much money. If you win the bet, and die early on them, they have to pay quite a bit of money to your beneficiaries.
As you grow older, the odds are more in the favor of your dying, so the policies get more expensive. However, you don't need as much. Most term life policies take this in consideration, so rather than charge you more for the same insurance, the amount you are insured for goes down.
How much insurance do you need when you are old? Your burial expenses should be covered in the very least. If your insurance salesperson is busy trying to sell you a whole life policy so you will be fully insured when you die at 90, consider what inflation will do to you. Let's say you are 35, and you buy $100,000 in whole life. You are paying about $1200 or so a year for it. How much will it be worth in 55 years? Let's assume we have an inflation rate of 4%. That money will be worth $10,590.53 in today's dollars. Ok, $10,590. Not a real good deal for your descendants, is it? Especially when you consider how hard it is to throw all that money into a policy for money you never get to spend. It's enough to make a banshee scream.
So to wrap this discussion of the grim reaper up, here are the ghoulish facts. You need a lot of life insurance when you are young. What you need as you grow older is much less, and each person's situation is different. Spend a little time going over the deadly statistics; it won't take you any closer to that dreaded day. On the other hand, it may make that final day a lot less dreadful for the people you leave behind.
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