The Weight of Money

I’ve finally made progress on getting life insurance. Recently, I woke up in the middle of the night in a panic because we didn’t have any yet. So, I got some quotes to work with and have selected a company to move forward with. Next up is the application process. To determine our coverage amount, I took several things into consideration. The standard calculations of 7-10 times your current salary seemed too cookie-cutter and unrealistic. Here are the initial numbers I calculated:

Current Debt

• House: $250,000

• Credit Cards: $16,000
• Student Loans: $30,000
• Total: $296,000

Future College Tuition

• Children: 1, 4

• Cost of 4 Years of College: $40,000
• Total: $40,000, $160,000

Annual Income Replacement

• Partner: $40,000

• Myself: $20,000
• Duration: 20 years
• Total: Partner $800,000, Myself $400,000

I ended up with a calculation of more than a million dollars of coverage for the partner. That seemed to be quite high and led me to to reconsider some options. For one, college tuition is highly variable and I already have no intention of paying the full college tuition for my children. Also, I realized that the annual income I was hoping for was to cover expenses that included savings for retirement and college tuition. Seeing that the number seemed too high, I also realized that while I would love to be able to stay home with our children (there is only one now, hopefully two in the next year), I’d probably be better off getting another job and not fully relying on life insurance benefits.

To lower the coverage amount, I reconsidered our actual expenses (both current and future projections). I calculated our annual income needs to see how off the numbers really are (but again, these numbers are just estimated projections and they too could be very off).

Annual Income Needs for the loss of primary income (twenty years):

• Property Taxes: $4,000 ($80,000)
• Food: $8,000 ($160,000)
• Clothing: $3,600 ($72,000)
• Transportation: $6,000 ($120,000)
• Utilities: $6,000 ($120,000)
• Household: $3,600 ($72,000)
• Entertainment: $2,400 ($48,000)
• Other: $12,000 ($240,000)
• Total: $39,600 ($792,000)

This amount is pretty close to the $40,000/annual income I had originally estimated (and I included elevated numbers since everything seems to get more expensive over time). Next I factored in the fact that a loss of primary income prompts a return to work on my part. Lets assume the 4 children scenario and that the loss of primary income comes right after the fourth child is born. I would need the full $40,000 a year until the youngest child enters primary school, about 6 years. At that time, I could assume that I would easily be able to manage a part-time job and would be able to decrease the needed annual income to $27,000. After the youngest child enters high school, about 9 years later, I could move up to a full-time position and reduce the our annual income needs to $10,000. This works out to the following life insurance needs:

• $40,000/year for 6 years: $240,000
• $27,000/year for 9 years: $243,000
• $10,000/year for 4 years: $40,000
• Total need over 20 years: $523,000

Partially considering this scenario and my reluctance to opt for a million dollar policy, I chose $750,000 in coverage for the partner. Going with the scenario above, this would leave $227,000 to pay towards current debt, a sufficient amount assuming our debt decreases by the time a fourth child is born. There is not additions for college expenses because I factored deposits into college savings account in the “other” annual category listed above.

For my coverage, I selected the $400,000 to provide $20,000 per year for twenty years - this is to cover food and child care costs that my partner would incur if I were no longer in our household. Also, the idea is that the partner should be able to cut back his workload some to manage parenting alone. This number may actually be too high, but if there is an instance where both of us pass away, it will cover all of our outstanding bills and provide for the care of our children.

One final note, life insurance should be reassessed with life circumstances changes. Getting more coverage than we currently means we’re paying more than we need to for something we may never use. However, time passes quickly around here and I want to be sure that I don’t have to reconsider life insurance for the next few years. Now, come child 2, 4, or 6 - I will probably need to see if these numbers still make sense for our family - in the meantime, I’ll be comfortable thinking that we’ve got enough coverage for now.

This entry was posted on Tuesday, September 18th, 2007 at 4:12 pm and is filed under family, income. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.