to consider buying:
1 Determine your annual after-tax income (from working, not investments).You can find this number on your tax return or W-2 form from the past year. (The reason you work with after-tax income is because life insurance death benefit payouts aren’t taxed.)
2 Determine the amount of money you need in order to replace your income for the appropriate number of years.You can find this amount by simply using the information in Table 2-1.
3 Consider your overall financial situation and whether you need to replace all your income over the time period you chose in Step 2.High income earners who live well beneath their means may not want or need to replace all their income. If you’re in this category and determine that you don’t need to replace all your income, apply an appropriate percentage.
TABLE 2-1 Calculating Your Life Insurance Needs
| To Replace Your Income for This Many Years | Multiply Your Annual After-Tax Income by |
|---|---|
| 5 years | 5 |
| 10 years | 9 |
| 15 years | 12 |
| 20 years | 15 |
| 25 years | 17 |
| 30 years | 19 |
Assessing your current life coverage
Before you rush out to buy life insurance, make sure you first assess how much coverage you may have through your employer and through Social Security. The amount of coverage you have could reduce the amount you need to purchase independently. Employer-based life insurance coverage is an easier issue to deal with compared to Social Security survivor’s benefits, so we address it first.
Employer-based life insurance
Some employers offer life insurance coverage. If it’s free, by all means factor it into your calculations for how much additional coverage you may need. (Refer to the preceding section, “Determining your life insurance need,” for more on calculating the coverage you need.)
For example, if your employer gives you $50,000 in life insurance without cost — and in Table 2-1 you calculated you should have $300,000 of coverage — simply subtract the $50,000 your employer provides to come up with $250,000 of life insurance you need to get on your own.
Keep in mind, however, if you leave the employer, you’ll most likely lose the provided insurance coverage. At that time, if your needs haven’t changed, you’ll need to replace the employer coverage.
Social Security survivor’s benefits
Social Security can provide survivor’s benefits to your spouse and children. However, if your surviving spouse is working and earning an income comparable to yours, he or she is going to receive few to no survivor’s benefits. Also keep in mind that Social Security survivor’s benefits aren’t paid to a surviving spouse until he or she is at least age 60.
Prior to reaching Social Security’s full retirement age, or FRA, your survivor’s benefits get reduced by $1 for every $2 you earn above $18,960 (the limit for 2021). This income threshold is higher if you reach FRA during the year. For example, the Social Security benefits of those reaching FRA during 2021 are reduced by $1 for each $3 they earn above $50,520 until the month in which they reach FRA. (Check out Chapter 10 for more on FRA and Social Security benefits.)
If you or your spouse anticipate earning a low enough income to qualify for Social Security survivor’s benefits, you may want to factor them into the amount of life insurance you calculate in Table 2-1. For example, suppose your annual after-tax income is $40,000 and Social Security provides a survivor’s benefit of $15,000 annually. You calculate the annual amount of life insurance needed to replace like this: $40,000 – $15,000 = $25,000.
www.ssa.gov) that lets you obtain updated benefits estimates, verify your earnings, and take other actions. Or, you can contact the Social Security Administration (SSA) for the “Request For Social Security Statement,” Form SSA-7004, which gives you an estimate of your Social Security benefits. You can request this form on their website or by calling the SSA at 800-772-1213.
Figuring out what type to buy
When looking to buy life insurance, you basically have two choices: term life insurance and cash-value insurance. The following sections outline these two options and their differences and help you determine which may be better for your circumstance.
Term life insurance
Term life insurance is pure life insurance protection. It’s 100 percent life insurance protection with nothing else, and, frankly, in our opinion, it’s the way to go for the vast majority of people. Agents typically sell term life insurance as so-called “temporary” coverage, which is just fine because life insurance is not a permanent need during certain years of life when others are financially dependent on your employment earnings.
Remember that the cost of life insurance increases as you get older. You can purchase term life insurance so that your premium steps up annually or after 5, 10, 15, or 20 years. The less frequently your premium adjusts, the higher the initial premium and its incremental increases will be.
The advantage of a premium that locks in for more years is that you have the security of knowing how much you’ll be paying over that time period. You also don’t need to go through medical evaluations as frequently to qualify for the lowest rate possible. Policies that adjust the premium every five to ten years offer a happy medium between price and predictability.
