I Had a Dream Last Night and You Were Dead!
The commercials for the life insurance industry are puzzling. They portray an otherwise happy couple usually ages 30-40. They have kids. They are in the kitchen of their happy house when the wife (always the wife) turns and says one of two things.
- “Our friend/neighbor (also 30-40) died and there was no life insurance.”
- “I had a dream that you (always husband) died and we had no money.”
Then the guilt statement. “You have insurance, right?” or “That can’t happen to ‘us’, right?”
Life insurance is a legitimate product. But it tends to be vastly oversold. There’s a fun website that addresses this called “Odds of Dying calculator for any age and sex” Let’s take a 40 year old male. The chance he will die is 1/389 or .0026. Add 20 years and the same person and at age 60 he has a 1/83 chance of dying or 0.012. When you buy life insurance you are betting against the house. Meanwhile, one website I saw put it coyly. The likelihood you will die is 100%
Life insurance is a useful product but whether in or out of divorce, it is often acquired on the basis of tradition rather than facts. In 1860 the average life expectancy in the US was about 40 years. In 1940, it was just over 60 years. Today it approaches 80. Even as late as the 1940s, industrial accidents and vehicle collisions killed lots of young people. Today, those risks are much, much smaller.
Some people maintain life insurance as a kind of “jackpot” at death. Your spouse and kids will now be rich because of your demise. That’s a strange way to approach estate planning. But, you will certainly be the star of the show (i.e., decedent) at the funeral.
The smarter approach is to look at life insurance as a tool. Once you have kids your death while they are minors does leave your spouse not just without your income but the support responsibilities you both undertook when you decided to have kids.
So how much is enough? Let’s assume you and your spouse each earn $75,000 a year or $150,000 gross. Let’s call that $120,000 net of taxes. If you look at the Pennsylvania support guidelines, they suggest that the cost of supporting two kids is about $28,000 a year at that income level with an assumption that you would each contribute half and that it would be deployed to pay for housing, health, clothing, food and all of the other basics. Let’s further assume that one child is age 10 and the other is 8. On average your death means you will leave an unfunded obligation of $14,000 a year for an average of 9 years. That suggests coverage of $126,000. The cost of that will be pretty small and you only need to buy it for 10 years since that is when your youngest will become an adult.
Now before you start ringing up your agent to buy insurance, pause. If you die at 40 what resources do you have before you buy insurance? Many employers provide insurance equal to one years’ annual salary. So, there is $75,000 that may be instantly available thanks to your employer. Then, how much is in your 401K retirement plan? Let’s again just pick a reasonable number and say your balance is $50,000. You won’t be needing that for retirement anymore. You’re dead. But did you notice that $75,000 in employer life insurance and $50,000 in retirement cash (which is available to your surviving spouse) is very close to the $126,000 of estimated needed coverage?
Candidly, these numbers are very tight. Most couples making $150,000 would probably say that $28,000 for supporting two kids, all in, is light. That merits analysis of what expenses you now have and expect in the next 10 years. It will cost money to bury you and your kids might need some counseling. The retirement money may be subject to some taxes, but it isn’t all needed at once. You may want to use life insurance to fund college but realize that the money you are spending for the insurance is money you might otherwise save in a 529 plan. And odds are very high that you won’t die before they finish college.
There are dreamy causes. People want to see their mortgage paid off. A worthy cause but an unlikely result (your premature death). People like to leave money “for the family.” Also, a worthy cause but the premium payments are being deployed for a remote possibility when they could be used to save and invest. Think of it as if you are 60 years old and sitting in a railroad passenger car full of other men, all age 60. What is the likelihood that you will be “the one” of the 80 people riding in the car to die this year. If you are 40 years old use the same example except pretend you and the other 380 passengers in a 747 aircraft are all age 40 males. One of you will die during a year of flights.
It is always wise to buy life insurance early, before disease starts to get a grasp on your blood sugar and cardiac system. But people in modern America often buy coverage more out of the romance of providing than the actual need. Coverage is cheap today but that’s largely because the “house” is betting that you won’t die.
This subject commonly arises in a divorce setting. The law says a court can impose such an obligation but it’s rarely done. An insurance clause is a reasonable element of any agreement where there is child support, alimony or property payments due in the future. At age 40 a million in coverage is a modest $25 a month. But by 60 the cost is $135 for a woman and $200 for the man. The key is to think cautiously and shop wisely.