WCI Financial Boot Camp Step # 2 Term Life Insurance
Welcome back! I'm glad you're still here. How did your homework last week go? I hope you all now have disability insurance (or no need for it.) If not, flag this email for later review and go back and do last week's homework. The knowledge doesn't do you any good, only the behavior. So make sure you're doing both.
Today we're going to talk about life insurance, which is critical if you have anyone else depending on your incom. See that picture up there? That's me with my daughter Whitney on top of the Grand Teton. Whitney is an occasional columnist on The White Coat Investor and a frequent partner in my outdoor adventures. But I carry life insurance so her life wouldn't change if I fell off a cliff. But before we get into all that, a word from this week's sponsor.
Step Two Sponsor
Step Two is sponsored by MD Disability Quotes , A Physician Specialty Firm. Whether you're just starting out or starting over, protecting your income with disability and life insurance is an absolute priority to continue funding obligations you've committed to. When building a disability or life insurance contract, you will want to make sure that it's built specifically for you based on your age, gender, medical specialty and state of residence. Our team maximizes all discounts applicable to obtain the best cost per dollar of coverage for you. Brokers Scott Nelson-Archer and Amber Stitt, along with the team (Joe, Ryan, Gary, and Matt) have 25+ years of experience helping thousands of physicians across the country protect their future with disability income insurance and low-cost life insurance policies. Give them a call/text or drop them an email; you will be glad you did! Call 713-966-3932, Text 281-770-8080, click on their sponsorship or drop them an email at Info@MDDisabilityQuotes.com.
Step 2: Term Life Insurance
Can I Skip This Chapter?
Is there anybody who depends on your income besides you? If so, you need life insurance and should read this chapter, even if you already own some life insurance. If nobody else is depending on your income, and you have enough assets to pay for your burial, wonderful! You can skip the rest of this and I'll see you next week.
More Income Insurance
Just like disability insurance doesn't reverse your disability, life insurance doesn't bring you back from the dead. Its purpose is to eliminate the financial consequences of your death. It will do nothing for the other consequences. In order to figure out how much insurance you should buy, you will need to determine what the financial plan will be if you died tomorrow. Then, buy enough insurance so that, financially speaking, the consequences are the same whether you live or die.
For example, our financial plan is for my wife not to ever have to go back to working for money. That means my life insurance serves as an "instant retirement nest egg." When we first started earning money, I needed enough life insurance that if I died, she would have a nest egg that, managed in a reasonable manner, would last the rest of her life. We also needed enough to pay off the mortgage and enough to cover a big chunk of our childrens' education expenses. Now, over the years our real retirement nest egg has grown, our mortgage has been paid off, and the college funds have grown. Thus, our need for insurance has become less and less over the years. At a certain point we will have no need for life insurance, as we will be financially independent from paid work.
Bear in mind that some couples choose to buy life insurance even on the stay-at-home partner. The services provided to the family by that partner also have a monetary value. It really just comes down to what the financial plan is if that person dies.
Term Versus Permanent Insurance
As you can see, there is only a limited period of our life where we will need life insurance. So the least expensive way for us to pay for that need is to buy what is called "term" insurance, that is, insurance that will only pay out if I die during a specific term. There are other types of insurance, collectively called "permanent" insurance, that will pay out whenever the insured dies, whether that is at age 30 or age 90. Obviously, permanent insurance costs a lot more than term insurance, because it guarantees that if you keep paying the premiums, your heirs will get the death benefit eventually. How much more does it cost? Well, it depends on what type of term insurance and what type of permanent insurance, but it would not be unusual to cost ten times as much to get that permanent death benefit.
To make matters worse, permanent insurance has an almost endless number of variations, and has a veritable army of salesmen working their tail off to sell as much of it to you as you will buy, using dozens of well-honed sales techniques. For the vast majority of doctors and similar high income professionals, buying any permanent insurance policy is optional at best, and probably a financial error. The reasons why are a bit beyond the scope of this book, but suffice to say that at this point in your financial life, what you need is term insurance, and a lot of it. If you wish to add on a permanent life insurance policy at some point down the road, be sure you understand exactly what you are buying and are committed to holding it until death. In general, permanent life insurance doesn't replace term life insurance, so it's not an "either/or question." It's a term or term plus permanent question. Either way, you need some term insurance.
How Much Life Insurance Do You Need?
Deciding how much life insurance to buy requires you to do some rudimentary math. However, if you are like most doctors, the number you will end up with will be between $1 Million and $5 Million. The calculation works like this:
Determine how much income your loved one(s) would need going forward if you died today. Now multiply that by 25. That will provide a nest egg for them to live off of for the rest of their lives.
Now, look at your latest mortgage statement. Add on the amount you still owe. If you are currently renting, take a look at what the house you would like your loved ones to live in would cost to buy with cash. Use that amount instead.
Next, consider how much you would like to have for your childrens' education. If you plan to pay for the entire experience, plan on $50-200,000 per child.
Now, consider any other large ticket items there may be, such as your spouse's student loans, the mortgage on a vacation home, or any other debts. Remember that your student loans are forgiven if you die.
Add it all together. Subtract your current nest egg and college savings from it. Now, round up to the nearest $1 Million. That's how much term life insurance you should buy.
Is the number between $1 Million and $5 Million? Good. Don't worry about buying a little too much. This stuff is cheap and it's better to have a little too much (especially when future inflation comes into play) than too little.
How Long Of A Term?
Remember the idea with buying term life insurance is that you need to save and invest enough money every year to eventually become financially independent. In order to decide how long of a term you need, you need to know about when you expect to be financially independent. This will require another financial calculation. If you don't have the ability or desire to make this calculation, buy a 30 year level term policy. That gives you 30 years to learn how to make this calculation, and hopefully you'll learn it a lot sooner than that. It might cost you a little extra, but since you can't really buy a term longer than 30 years, at least you won't come up short.
How to Calculate Length of Term Needed/Years to Financial Independence
If you would like to learn how to do this calculation, it's not that hard. Open a spreadsheet, such as Microsoft Excel, and input a calculation called "NPER." You will need to input a few variables. Here's how to do it:
NPER is the "number of periods," i.e. number of years, until you reach your financial goal. This is the solution of the equation.
RATE is the first variable, and is the annualized rate of return on your investments. Adjusted for inflation, I think 5% is a reasonably conservative number, and is what I would recommend using in this calculation.
PMT is the second variable, and is the payment, or amount of money you intend to save for retirement each year. When you enter it into this calculation, this is a negative number, so put a minus sign in front of it.
PV is the present value, i.e. the current size of your nest egg. It is also a negative number.
FV is the future value, i.e. the amount of money in today's dollars you need to retire. In order to get this, estimate how much income you will need per year in retirement, and multiply it by 25. This is a positive number in the equation.
Type is either a 1 or a 0, depending on whether you will be adding the payment at the beginning of the period (a 1) or at the end (a 0.) It doesn't matter all that much for the purposes of this equation.
So, let's say you want $100,000 per year to live on in retirement, and are saving $40,000 per year toward retirement. How long will it take you to get there? Here is what you would put into the spreadsheet:
=NPER(5%,-40000,0,100000*25,0)
The solution is 29 years. So if that is you, buy a 30 year term policy
However, let's say you are a bit more frugal and you already have $100,000 saved for retirement. You plan to save $60,000 per year and can live on $80,000 per year in retirement. What would your equation look like?
=NPER(5%,-60000,-100000,80000*25,0)
The solution here is 22 years. A 25 year term policy ought to be adequate.
What if someone is already well into her career but still needs life insurance? Let's imagine someone who has $1 Million already, is saving $50,000 per year but wants $100,000 in retirement income. How long should her life insurance term be?
=NPER(5%,-50000,-1000000,100000*25,0)
The solution here is 11 years, so a 10 or 15 year term is probably adequate.
As you can see, these equations don't require a precise calculation. If you're not sure about a variable, just guess, then round up. These are not irrevocable decisions.
How To Buy Life Insurance
Term life insurance is essentially a commodity. For the most part, it is a simple product. You pay a premium once a year, and if you die during that year, you get the face value of the insurance policy from the insurance company. If you don't die, you don't get anything. Any reasonably financially secure insurance company is going to be able to pay out if you die such that you should not spend a great deal of time, effort, and especially money trying to get a policy from a "better" company. You want the cheapest policy for the money. It's a commodity, like gasoline. Sure, there are a few purists who like to argue about the merits of Chevron gas over Texaco, just like some agents want to argue about the strength of Minnesota Life over Metlife. But in the end, it's just gas and it's just insurance. It all works fine.
So your goal when you go to buy term life insurance is to buy the cheapest policy you can get. If you are very healthy, this is a simple process. You simply go to an online site using software such as "Compulife" (see resources below) which will provide you quotes from dozens of insurance companies without requiring any personal information. You then print out the list of quotes, go to an independent agent (i.e. one who can sell you a policy from any company), and ask them to sell you the least expensive policy for the face amount and term you have already decided on. It is that simple.
If you are not healthy, or engage in dangerous hobbies such as flying, skydiving, SCUBA diving, or climbing, it gets a little more complicated. Here is where the independent insurance agent really earns his commission. He will have to informally "shop you around" to the various companies, to see which one will give you the best price.
Avoiding the Upsell
Most, if not all, insurance agents who you go to see for term life insurance will attempt, at least briefly, to sell you a permanent life insurance policy. It is best to be politely persistent, using a phrase such as, "I am here today to buy term life insurance only. If you treat me well today, I may be back at a later date to purchase permanent life insurance from you. But that date is not today." Better yet, just use an agent off my recommended list such as this email's sponsor and you won't have that pressure.
Annually Renewable and Laddered Policies
Although term life insurance is very inexpensive compared to disability insurance, there are a couple of ways in which you can save even more money on your premiums.
When you purchase a 20 year level term policy, your premium remains exactly the same for 20 years. In year 21, should you decide to hold on to the policy, the premium will dramatically increase and will continue to increase each year. But for the length of the term, the premium is level. If you expect to become financially independent relatively early in life, you may wish to consider an annually renewable policy. In the first few years, an annually renewable policy is less expensive than a level term policy. This can be very helpful both because your early career years tend to be more lean than later years and because it will give you more of your income that you can invest for the future, speeding your financial independence. But if you find you're not accumulating wealth as quickly as you expected, you can still just keep paying the premiums and keep that life insurance in force as long as it is needed.
Another option to consider is to ladder your policies. Instead of buying one 30 year level term policy, you can buy a 20 year level term policy and a 30 year level term policy, each for half the amount of insurance needed. The 20 year policy will cost much less, and after 20 years, you should have less need for insurance and can make do with just the 30 year policy.
Summary
Life insurance is much less complicated to purchase than disability insurance, but it is just as important.
Don't want to wait for Step 3? Consider just buying The White Coat Investor's Financial Boot Camp book now available on Amazon.
Your Chore List
- If you do not already have life insurance, but need it, get started today. First, calculate how much you need. Then calculate how long you need it for. Then go to a site such as http://term4sale.com or http://insuringincome.com and get a list of quotes. Now make an appointment, in person or by phone, with an independent life insurance agent, like Bob Bhayani, who sponsored this newsletter, at drdisabilityquotes.com to purchase a policy.
- If you already have life insurance, run the two calculations in this chapter to ensure you have enough and that it will last long enough. You may find you need to buy some more, but you might also find out you no longer need your policy and can cancel it.
Other Resources
Step by step guide to buying life insurance
Access to Compulife database- free instant quotes
List of techniques used by insurance agents to sell whole life insurance inappropriately
Still think whole life might be for you? Read through these questions first
Regretting buying a whole life policy? This post is for you.
Two steps down. Ten to go. Get your homework done and I'll see you next week.
Jim
James M. Dahle, MD, FACEP
Founder, The White Coat Investor
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