During the euphoria of expecting your first child, it’s bound to hit you—the realization that you now actually need life insurance.
Once this realization hits you, all manner of frightful worst-case scenarios blow through your mind:
- You get hit by a bus tomorrow and leave your pregnant wife without a husband.
- The bus hits you ten years from now, and your wife and pre-teen kid struggle to make ends meet.
- That damn bus takes you out 17 years from now, just as your college-bound teenager needs an influx of cash to pay for school.
…and then you realize you know next to nothing about life insurance! No one ever talks about this stuff! And you freeze in horror at every city bus that approaches you!
So, as a responsible dad you do need life insurance. Yes, it will make you face your mortality, which is crazy unpleasant. But once you get over the discomfort, it’s time to just get on with it and do the right thing: buy a life insurance policy. Protect your family. Buy peace of mind.
My wife and I spent two months shopping for our life insurance and defining all of our parameters. I felt that it was critical to get it done right as it would be very costly down the road if we were to change anything, so we really took our time with this.
Here’s how we went about our life insurance purchase. Just an apology in advance: this post will be… a little morbid. We’re talking about life insurance after all. I’ll try to keep the mood as light as possible throughout, promise!
Figure out how much you need if the unthinkable happens.
There are three unthinkable scenarios that my life insurance covers:
- I get hit by a bus and die.
- My wife gets hit by a bus and dies.
- We both get hit by buses and die.
As unpleasant as it is to contemplate, these scenarios must be thought out as to their financial impact on the surviving family. A death benefit (i.e. the money paid out to the surviving beneficiary when a policy holder dies) should reduce or eliminate this negative financial impact.
Some considerations include:
- Having enough of a life insurance payout to eliminate a mortgage.
- Creating a fund where the payout is used as a principal for interest and dividend income for the surviving family.
- Sufficient cash to bridge a very difficult time for the remaining family members.
- Perhaps your workplace may offer some life insurance coverage, whereby this lessens the need for additional life insurance purchased separately.
- Figure out the tax implications of receiving a death benefit: generally death benefits are not taxed as income in Canada or the U.S., as long as interest on the benefit has not accrued.
- You and your wife may need different amounts of coverage, as one spouse may earn more than the other and thus would require less coverage were the unthinkable to happen.
See what I mean about this being an uncomfortable process??
Figure out how long you need to be covered.
There will be a range of time in your life that your family will be particularly financially sensitive to a parental death. Generally the acuteness of financial pain is greatest early on in family formation, and gradually decreases over time.
Think about a new dad who just bought a house and is carrying the greatest mortgage burden he will ever carry. His first kid was just born a year ago and his wife’s expecting again. Money is tight, but as long as the new dad is working, all is good. But if disaster strikes, this dad had better be covered by life insurance.
Over time, as the mortgage is paid off and the kids get shuttled off to college, the need for life insurance lessens. After the kids are financially independent, life insurance is essentially a legacy inheritance for the adult children.
My wife and I determined that our greatest need for life insurance would be while our future kids are still living under our roof. We signed on before our first kid was born for 25 years term life insurance blended with permanent insurance (more on these types of insurance in a little bit). So our time range of most need for life insurance was 25 years from family formation.
Once you figure out what amount you need for a death benefit and how long you need to be covered, then you move onto the next step.
Get a broker.
Life insurance is not something that you shop for every day—it’s probably something that you shop for ONCE in your life. Even home and auto insurance might require repeat purchases over your lifetime. With life insurance, this is pretty much a one-time purchase so you want to make sure that you make the right decision right now.
To make a good decision you need professional help in the form of an insurance broker.
A broker should work for you for free. They get paid per policy that they sell, with their fee baked into the product.
Ask around and shop around for a quality broker. You want one who will spend a lot of time with you to figure out the products that are right for you.
Our broker was actually pretty great. He would meet with my wife and me at coffee shops near our house outside of office hours, and spent two months educating us about our purchase. He came recommended by two separate references and works for a well-known brokerage that regularly publishes personal finance articles in a Canadian national newspaper. He was also a pretty funny guy, which really helps if you’re talking about death and related grim topics the whole time.
Shop for your life insurance policy as if it is an investment.
A life insurance policy can actually be considered a financial investment, making it different from just about every other insurance product that’s out there.
So, how does this work? First let’s talk about the different types of life insurance products.
There are three basic types of life insurance: term, permanent, and universal insurance.
Term insurance is in effect for a predetermined term, say 25 years. It has the cheapest premiums of any type of life insurance; however, the downside is that once the term is over you never see the money again. Term insurance is meant for a time period where your family would experience severe financial hardship if you died, such as early on in family formation when you would have a hefty mortgage and young children, or even later on when your kids are still under your roof.
Permanent insurance is in effect for life. So you are guaranteed a payout because you are guaranteed to eventually die. Permanent insurance premiums are higher than for term insurance. You can arrange for permanent insurance premiums to be for a specific duration of time, say, 25 years. The nice part is that once the premiums are paid, you don’t have to spend another dime and your beneficiaries are guaranteed to get the death benefit.
Universal insurance is some weird hybrid of term and permanent insurance, and is too complex to get into in this article. It can have many features, such as increasing and decreasing premiums over the duration of the policy.
So, here’s the part about how life insurance can actually be an investment.
When you buy permanent insurance, the death benefit is often several times greater than what you pay overall in premiums. The reason for this is that in all probability you will die long after the last premium has been paid out (and all insurance is calculated on the outcome probabilities of a large number of people).
Meanwhile, the insurance company has whipped up your cash into a big frothy soufflé through various investment vehicles, multiplying your money many times over. So when you buy permanent insurance, you can see how your premiums can actually net you (well, at least your surviving children) a huge benefit once you finally kick the bucket.
The drawback of permanent insurance is that the premiums cost quite a bit. So, in order to get sufficient coverage, you have to pay much more than you would if you had term insurance.
The solution? Buy a blended insurance package.
Figure out what you need as a death benefit in the event that the unthinkable occurs and you or your wife get hit by a bus. Then, ask your broker to give you several options for a blended term + permanent insurance package such that:
- Your death benefit is sufficiently high enough to cover your family’s needs,
- You are covered by the cheaper, temporary term insurance during the most financially sensitive period of your lives (typically while children are still living under your roof),
- Your monthly premiums are at a reasonably affordable level, and
- The payout of the permanent insurance component is much higher than your combined lifetime premiums.
Now for the hail of arrows…
Hey, Anthony, what if I just got the cheaper term insurance and invested the money saved by not getting permanent insurance?
Yes, this works if you are super-disciplined and are an investing ninja. You would have to honestly assess whether or not you have the vigilance to take advantage of the savings of not having permanent insurance, and persist with investing these savings over the long haul (we’re talking decades here). I’m not like that, so I went blended—it puts a forcing function in place where I have to pay into my policy.
Isn’t buying a house or stocks a better investment than this blended life insurance frappucino thingy?
Except that the primary reason why you want to buy life insurance is to protect your family from financial disaster in the case of a parental death. The financial return is a secondary concern. A cherry on top of the morbid sundae, if you will.
What if I don’t have the spare cash to buy an expensive blended policy, and just want to get term insurance?
Well, first of all if you blend in an appropriate ratio, the premiums don’t have to be super expensive. And if term insurance better fits your budget, than by all means just get term. Lots of people do that. I am just presenting a way to buy life insurance where you actually can get back more money than you put in over your lifetime.
Here’s a couple more nuggets…
Don’t put it off.
Life insurance gets exponentially more expensive the older you and your wife get. Once you hit your 40s and 50s, it gets hella expensive.
And forget about it if down the road you develop some sort of medical condition that makes you a health risk in an insurance company’s eyes.
So, don’t put it off. It is way more cost-effective to sort this thing out when you are young and healthy.
Once you set it, forget about it.
The thing about life insurance is that once you lock in, there’s no need to fiddle around with it. Once you have the policy, there are only two paths you can take:
- Stick with the program.
- Quit.
Since examining your life insurance policy after you lock in is like staring the Grim Reaper in the face—and for no real benefit—it’s just best to forget about it. After all this purchase is meant not only to cover your family in the event of a catastrophe, it’s meant to buy peace of mind as well.
Hence, once you set it, just forget about it.
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So that’s my spiel on buying life insurance. Yes, it’s something that you have to do to protect your family. Yes, it is crazy unpleasant to confront your mortality while making this purchase.
But it does buy you quite a lot: when configured correctly a life insurance policy can actually be an investment; it buys you coverage if catastrophe occurs; and last of all it buys you invaluable peace of mind.
Hit the comments below, I’d love to hear your thoughts on this grim, yet very important topic!
Your friend,
Anthony Kim