What is the purpose of life insurance? In short, life insurance protects us against the financial impact of someone’s death. This could mean either of two things: Loss of income or financial costs incurred to replicate the functions normally performed by a primary family member. Think child care, housekeeping, or elder care costs.
In the military, we’re used to thinking of life insurance as $400,000 in SGLI (Servicemember's Group Life Insurance) whether we need it or not. However, that’s a one-size-fits-all type solution, which isn’t the right answer for most situations. If we think outside of this box, it’s usually because some helpful insurance salesperson comes along and tells us what we need. Having someone else tell us what we need, then turning around to sell it to us, isn’t the right answer for any situation. (For more, see: The Best Life Insurance for Military Families.)
Life insurance shouldn’t be the the most important thing among your personal finance decisions. However, you should take some time to figure out what kind of life insurance policy you need. In most cases, you might determine for yourself that your $400,000 SGLI isn’t enough. Here's a walk-through of five considerations that should help determine how much life insurance you need.
1. Know What the Policies Provide
Most people think of life insurance coverage in terms of how much their monthly premium is. That’s like buying a car based upon how much you want your monthly payments to be. Instead, you should take the time to understand your policy, and to fully understand the clauses, fees, and everything else that the insurance company could put into your contract.
For a simple term insurance policy, this could be straightforward. It’s definitely straightforward when you’re talking about SGLI or its cousin, VGLI (Veterans Group Life Insurance). There’s no underwriting requirement, and your premiums are publicly available. However, if you have a policy from another provider, or are already paying into a policy that you bought (or were sold), you should take some time to understand it. You definitely should do this before you buy another policy.
Understanding the ins and outs of your life insurance policy or possible alternatives is not a simple matter. You might need to discuss your insurance needs with your installation’s financial counselor or a fee-only financial planner. While most states do not allow financial advisors or financial planners to compare insurance policies without an insurance license (most fee-only financial planners do not have a state insurance license), they can help analyze your insurance needs and help you determine how much you need as well as refer you to low-cost insurance agents, who can help you analyze your specific policy and price out new policies.
2. Life Insurance Should Help Replace Income
When you look at the purpose of life insurance, it’s to replace the lost income potential over the lifetime of the insured. Most service members will want to make sure that their insurance policy is enough to allow their spouse to pay off the mortgage on the house, as well as provide cash flow to support their family if they pass away. Most people will find that the $400,000 SGLI/VGLI default policy is not enough to meet this goal. Think about this: If you died today and your spouse only received $400,000 SGLI/VGLI, how long would that last? The answer is simple. It would last about as long as your $400,000 divided by your most recent salary. In other words, probably not as long as you think it should.
You might find that with some shopping around you can find term insurance pricing that is competitive—if not lower—than VGLI. Not always, but if you’re in reasonably good health with no significant red flags, you might be surprised at how much insurance you could buy under a 20- or 30-year level term policy.
While we’re on this point, child life insurance is almost never a good idea. First, children generally don’t produce income. If you’re not replacing lost income, then what is your insurance policy for? There are two reasons people buy children’s life insurance, and both of them are usually reasons insurance companies sell these policies … people don’t buy them on their own. First, there’s the emotional component for the loss of a child. While this is definitely a very emotional topic to discuss, would an insurance policy really help you get over the loss of a child? If not, then don’t let someone pull your emotional strings to dump money into a policy that really wouldn’t provide much condolence. Second, an agent might convince you that if you buy a whole life policy for your child, you can lock in low insurance rates early. By doing this, you’re actually doing your child a favor! Don’t fall for it. Instead, let’s talk about what whole life insurance does. (For related reading, see: When to Update Your Life Insurance Beneficiaries.)
3. Life Insurance Shouldn’t Be Thought of as Permanent
This is where we explain the difference between a term insurance policy and whole life. While there are a lot of differences, the primary one you should know is this: the premiums on a term policy are only flat for the term of that policy. For example, the premium for a 10-year term remains the same for that 10-year period. However, since premiums rise with age, you’ll find that premiums will go up when you try to renew at the end of that term.
With a whole life policy, the premium you pay stays the same for the duration of the policy. Hence the phrase “whole life” means that the premium stays the same forever. In order to make this feasible, insurance companies end up overcharging in the early years (i.e. when you're in your 20s and 30s) and undercharging in your later years (in your 70s and 80s). However, since insurance companies are in business to make money, you’ll find that they’ll overcharge more money than they undercharge.
The thing is, most people only need life insurance during a crucial period in their life. That period should be defined as the time between when you start a family and when you reach financial independence. In your early years, you probably don’t have anyone depending on your income. If you died, your beneficiary might receive a nice sum of money, but they wouldn’t be destitute if they didn’t. After you retire, you don’t have any earned income to replace. The crucial period is between when you start a family and when you retire. In other words, it’s where your family would desperately need to replace your income if you died.
However, you don’t need life insurance forever—unless you plan to never retire.
4. It's Not Always Necessary
Life insurance isn’t necessary once you’ve reached financial independence. However, it can still be useful if you’ve re-established new goals and it can be a very useful estate planning tool. If you’ve moved on from needing to have an income and have started charitable work or other goals, you can still use life insurance to ensure that your project outlives you. This might be an important consideration, even if you’re financially independent.
There are many other things that a life insurance policy can help you achieve when you look at it from an estate planning perspective. However, most of these concepts are beyond the scope of this article. For more information, you should probably talk to an estate attorney or fee-only financial planner. (For related reading, see: Who Should Be Your Life Insurance Beneficiary?)
5. Life Insurance Isn’t Just for the Primary Breadwinner
Most people think of life insurance as replacing lost income. However, what would happen if your supportive spouse passed? You would have to replace the value that your spouse adds to your family. For most families, at a minimum this includes the cost of replacement child care and house care/house cleaning. If your spouse has a job, you’ll have to replace that too.
Think of all the things that your spouse does around the house. While an insurance payout might not make up for that lost value, you will have to hire someone to do all of the chores that you won’t be able to do yourself. This is an often-overlooked consideration, but definitely one of the most important. For example, if my wife were to pass, I would have to:
- Enroll my children into child care programs during the summer while I work.
- Enroll my children in after-care programs during the school year.
- Hire a babysitter to care for my children during the times that programs aren’t available.
- Hire a housekeeper to do basic home upkeep.
- Hire a dog-sitter.
- Hire someone to help me manage my blog and financial planning business.
While family SGLI does provide spouse protection, it goes away after you transition. Also, you might find that this isn’t nearly enough to cover the financial loss of your spouse, particularly if he or she has a decent job or career, runs your rental properties, or has a side business. (For related reading, see: 5 Debt Plan Considerations for Military Families.)