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The New Math Of Mortgage Refinancing

The New Math Of Life Insurance

The world of financial planning is filled with so-called Rules Of Thumb.  Many of these quick principles are useful and provide a way to make complicated concepts easy and memorable.  One such rule is used in determining your life insurance needs by multiplying your income by 10.  So, if you earn $40,000 per year you should have $400,000 of life insurance in place.  The idea behind this life insurance rule of thumb was that a surviving spouse/family could invest the policy proceeds and earn 10% per year on it (replacing the lost income).  I remember the days of double-digit stock market returns very well.  I even vividly recall being fired by a client that was unhappy with a 30% annual return in their managed account with me!  Times sure have changed. 

Financial planning for the future is based on a variety assumptions, and right now the financial community is in turmoil trying to find some agreement on where these numbers should be.

First Determine How Much Life Insurance Would Be Needed To Pay Off All Debts

There is a lesser known approach to determining life insurance needs that may make more sense in today’s difficult economy.  Rather than attempting to replace the entire income of a deceased spouse, consider a two-part analysis that starts with all family debts being paid off.  For example, without a home mortgage, car payment, or credit card payments, how much income would the family need?  In many families, the income of the surviving spouse would be sufficient to support the family if all debts are paid off.

Determining How Much Life Insurance You Need To Replace Lost Income

Based on the current economic climate, I would have to suggest using a multiplier of 20 rather than 10.  This would require an earning rate of just 5% to replace the lost income.  Even 5% may seem a bit high based on 1% CD’s and a decade of a flat stock market, but we have to start somewhere.

Consider the following example of to combine the concept of paying off debts and replacing income (a blended approach):

Home mortgage $180,000

Credit Cards $10,000

Car Loans $30,000

Life insurance needed to pay off all debts $220,000.

Family income needed monthly assuming all debts have been retired is $1,500. 

$1,500 x 12 (to determine annual amount) = $18,000

$18,000 x 20 (to determine life insurance amount needed) = $360,000

Total life insurance need = $580,000

This approach makes so much more sense, especially in today’s economy.  Of course, additional sums can be added to fund college or other family priorities. 

As a financial planner, I have been on the receiving end of many phone calls from surviving spouses.  The most tragic are those with young children and where little or no life insurance was in place.  The real tragedy is how inexpensive term life insurance can be.  A younger person in their twenties or thirties can buy $500,000 in coverage for less than $30 per month and lock this rate in for 20 years.  Can you afford to not have coverage in place when it is this affordable?

I personally use Select Quote and have for years.  No, they are not paying me a penny for making this recommendation.  They will not try and sell you other expensive forms of life insurance (such as whole life) and do a good job of shopping out your profile to get the best rate.  Life insurance rates are available right now at all time lows.  Take advantage of the savings and consider locking in your rate for 10 years or longer (using a level term life insurance policy).

For more information on who needs coverage and how to buy it, please refer to my prior article on life insurance needs.  For an even more accurate life insurance needs analysis, I recommend using a life insurance needs calculator.

Helping you make the most of God’s money!

James L. Paris
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