Life insurance (part 2)

On Monday I posted part 1 which covered how we started thinking about life insurance and came to the decision to get it after two little cubs joined our lives.  To read that click here. 

Once we decided that we wanted to get life insurance, and had a rough idea of what we wanted it to accomplish (Foxy Lady needed a bridge until she found another partner, I needed something to allow me to raise the boys on a single income), we actually had to go out and do it.  When thinking about life insurance, the first thing you need to do is decide between the two major types (I’m not an expert here, and I know there are a lot of nuisances, but this is my general understanding; any readers who can shed a little more light, please do so)—whole life insurance and term life insurance.

 

Whole versus term

With term life insurance, basically you’re signing up for a limited period of time (10-year or 20-year policies are common) to have life insurance and then when the “term” is up your policy expires.  If you’re lucky and you outlive that 10 or 20 years, your policy is done and worthless (but you’re lucky because you’re alive, right?).  Prices obviously vary quite a bit, but if you’re young and healthy, this type of insurance is very inexpensive—Foxy Lady and I each have a 10-year term policy for $1.5 million and we pay $50 per month for it.

A whole life policy is very different in that it lasts until you die.  So with the term policy, after the term (in our case 10 years) is done, the policy is done; with whole life, so long as you keep paying those monthly premiums, the policy will last as long as you do, if you live another five years or another 55 years.  Whole life policies are much more expensive (when I was shopping for this stuff, a $1.5 million whole life policy for me would have been about $1300 per month), but that kind of makes sense.

With term policies, especially when you’re younger like Foxy Lady and I are, the chances of us actually using the policy are very low.  The probability of us dying in the next 10 years is about 2%.  So the insurance company is really counting on us having that 10 year policy, paying our premiums every month, and then after 10 years they pocket all the money and we don’t see a dime.  Of course, it’s worth it to us because there’s always that small chance that the nightmare scenario happens, and that’s what insurance is for.

But with a whole policy, there is a 100% chance that you’ll get your money because there’s a 100% chance that you’ll die eventually.  That’s what makes it so much more expensive than term policies.  If I bought that $1.5 million policy for $1300, in a way I am just socking away savings into a life insurance policy that will go to Foxy Lady when I die.  It’s guaranteed that she’ll get that money.  In this way, whole life insurance policies have a bit of an “investment” feature the same way an IRA might have.

 

Which one did we pick?

As I mentioned earlier, Foxy Lady and I picked 10-year term policies, and here is why.  First, we decided for term life insurance instead of whole life insurance because I think you can actually do a lot better investing your savings in things like a 401k, IRA, or brokerage account than with a whole life insurance policy.  Remember, we each would be paying about $1200 more per month for whole rather than term life insurance.  That’s a lot of money, and if you do back of the envelop calculations, if you invested $1200 per month, it would only take you about 30-35 years to get to $1.5 million.  I was 36 at the time we got life insurance so if I had to take the over/under on if I’d make it another 30-35 years, I’d probably take the over (statistically there’s over an 80% chance that I’ll live another 30 years).

Once we decided on term life insurance, we had to pick the “term”.  Should we go on the short end like 10 years, 20 years, or really extend it out to something like a 30-year- term?  At 10 years, our premium is $50 per month; had we taken a 20-year term the premium shot up to something like $125 per month, and at 30 years it was something like $700 per month.  On the surface it may seem counterintuitive that the longer you have a policy the more expensive it gets, but it starts to make sense if you think about it.  The chances of us dying in the next 10 years is pretty low, about 2%; but over the next 20 years it’s about 6% and over the next 30 years something like 18% (it surprised me it was that low, I expected it to be a lot worse).  So the longer you make the term the more a term policy starts to “look and act” like a whole life policy.

This is a point Foxy Lady and I talked about a lot.  We decided on a 10-year term policy because it was the least expensive, and that’s always a good thing.  But then we also thought about what our financial situation would be like in 10 years when the policy expired.  At the time we had one little cub, ‘Lil Fox who was two years old at the time, and we were expecting our second, Mini Fox.  When a 30 year policy would expire they would be well into adulthood, out of the house, and on with their lives (hopefully).  So after 30 years, Foxy Lady and I would be in a similar situation to where we were before we had kids.  Remember that it was only having little kids and the responsibility of taking care of them if something happened to one of us that prompted us to get life insurance in the first place.  So a 30-year policy was out.

Then it came down between picking a 20-year policy or a 10-year policy.  The 20 year option was attractive because it basically saw us through the boys’ childhoods; after 20 years ‘Lil Fox would be finishing up college and Mini Fox would be starting college (by that time we should be free and clear since we are saving for their educations).  With the 10 year option they would be about halfway through their childhood, so that seemed to tip the balance in favor of the 20-year option.

But then we started thinking about our financial situation in 10 years and  what that would look like if the doomsday scenario happened—we got a 10 year policy and then one of us died in year 11.  I suppose the uber-doomsday is both of us die after 11 years—are you kidding me, how can I even think about something so horrible (do you see what I mean?  Thinking about life insurance sucks).  We’re diligent savers, having built a nice little nestegg when both of us were working, still maxing out our 401k accounts, and building up equity in our home.  After 10 years based on some simple projections, we hope to have a net worth of $4-5 million.  Looking back on that doomsday scenario but knowing we have a $4-5 million backstop, we felt okay about things.

If you remember, Foxy Lady would replace me (with a guy who hopefully had an income) while my body was still warm so she would have more than enough money to see her through.  I would want to raise the boys without marrying again, so the stakes are a little higher for me, but even then I would be fine.  So as we thought about it, we really only needed life insurance to get us through a few years while we built our net worth up.  Once we got to $4-5 million, if tragedy struck, financially we knew those we left behind would be okay.

So that’s how we settled on a 10-year term life insurance policy.

 

How much insurance to get?

Once we knew we wanted a term policy and once we knew we wanted it to be for 10 years, the last thing we had to do was figure out how much life insurance to get.  This is probably the most important part because it’s what you’ll get if tragedy strikes, but in a weird way it was the easiest decision in the process.

A lot of places have life insurance calculators.  You put in information for your current situation like how much you currently make, do you have a mortgage, how many kids do you have, etc.  And it spits out a number for how much insurance you should get.  As you can imagine, since these are on the insurance companies’ websites, they tend to give you really high numbers.  When we did our research, it was telling us that we should each get something really high like $2 or even $3 million policies.  On the surface that seemed really high.  When Foxy Lady and I thought about those numbers (again, imagining life without the other—good times), they seemed more than enough.

The good news was that the insurance wasn’t all that expensive.  A $1 million policy was about $35 for each of us (Foxy’s was a little lower since she’s a woman and 18 months younger).  For $1.5 million it was $50, and for $2 million it was $70 per month.  $1 million seemed like plenty for us but since getting a little more didn’t seem all that much more expensive, we ultimately decided to go with a bit of a middle-ground option and settled on $1.5 million for each of us.  True to form for a sales guy, the dude we bought the policy from tried to upsell us to $2 million and gave us all sorts of reasons why people in our situations really needed the additional coverage.  Gotta love sales people.

 

Dang, this has been two long posts on life insurance.  Fortunately for Foxy Lady and me at this point, it’s all set up and we do the automatic withdraw every month and we don’t think about it.  But I can tell you when we went through it, it was a very difficult process, imagining losing the loves of our lives and imagining moving forward with our boys but without our partner.  It sucked.  But it was something we felt we needed to do for the little guys.  I’m convinced we’ll out live our 10-year policies and never use them, so in that way it seems like a total waste.  But the very nature of insurance is you use it when that one-in-a-million tragedy happens.  So we have our bases covered.

I hope this glimpse into one of the harder financial decisions Foxy Lady and I had to make was helpful.  What about you?  How do you look at life insurance?