Life Insurance: Choosing Enough Coverage Is Key

Life insurance, or lack thereof, can play a very important role when determining the potential success or failure of a financial plan. But most people don’t understand the financial impact it can have on a family if a spouse (or both) dies too soon. Consumers tend to focus solely on the cost of the insurance, and would rather forego paying the premiums, or they may be willing to pay a smaller premium for a smaller death benefit.  Therefore, many people risk leaving their loved ones financially exposed in the unexpected event of premature death. 

A Real Life Example

The following story and example hopefully will bring light as to why you should be considering buying life insurance or reviewing your existing coverage to make sure you and your family are adequately covered. I recently learned of someone who recently died from cancer. He was only 35 years old and he left behind a wife and two small children. I don’t know anything about his financial situation, and this isn’t a story about his family’s future. But I began thinking about, What if this were a family I advised? What would life be like for them if they didn’t have coverage? Or what if they had adequate coverage? How would the story unfold? (For more, see: Life Insurance: putting a Price on Peace of Mind.)

I imagine this family was just like any new family. They were working hard, paying the mortgage and bills, saving money for emergencies, retirement and college. They were excited about their future, growing old together, raising their children to go to college and get married one day, having grandchildren. They were leading a very fulfilling life as they had decades of memories and experiences ahead of them. Unfortunately, they received news the husband had cancer, their ambitions were cut extremely short due to one of the worst things that can happen to a person. Now, he is gone, and wife and children are left to figure out what to do now.

Little or No Life Insurance

Let’s assume for a moment the family did not have any (or little) life insurance. The immediate impact is the family’s financial picture changed for the worst the moment the husband passed away. Maybe he was the sole income provider. That would mean the wife would have to go get a job, and hopefully it paid as much as her husband made annually. The kids would have to be put into some type of day care. It may mean having to downsize the home because they couldn’t afford the mortgage, or they would have to cut back on expenses they once considered customary. 

In summary, there would be a need for an extreme lifestyle adjustment because of the loss of the human capital value of the spouse. Right now, you may be thinking, “So what? The woman just lost her husband and she has more important things to tend to.” The answer is you’re right and that is the point of this story. 

Choosing Enough Coverage

Now, let’s assume they did have life insurance. Let’s assume the husband’s annual salary was $100,000 a year. Their annual expenses, excluding the mortgage, was $50,000. The children are three years old, and the family wanted to be able to send both kids to public college without taking out student loans. They had a mortgage on their home of $200,000, about $10,000 of credit card debt, $25,000 in car loans and $25,000 in emergency savings.

How much insurance should they have to ensure the family is taken of financially in case of a premature death? Using a basic formula, he should carry a policy of at approximately $1.5 million. That would leave the family with income for the next 15 years until the children turn 18, it would provide an opportunity to have enough money to set aside for the children’s future college expenses, and money to pay off the mortgage and other debts. If this were the family’s outcome, even during a tragic event, they would be okay financially because they planned for the unexpected.

Now, compare the two situations above. Which would you prefer for yourself and your loved ones? Is it worth paying a small amount of money for protection in the worst-case scenario? This situation doesn’t just apply to life insurance. There are other events that can cripple a family financially, such as disability or needing long-term care. Money isn’t everything, but the life insurance policy can give the family peace of mind they will be okay.

This example is not meant to single out a family experiencing a difficult life experience, but it does demonstrate the need to protect what you have and who you love because life can change at the flip of a switch. (For related reading, see: How Much Life Insurance Should You Carry?)