Life insurance may be the most important money you will ever spend

I have a really important question for you. It’s morbid. It’s painful. And you’re not going to like it. But it’s possibly the most important personal finance question you can answer.

If you die today, what does life look like financially for those you leave behind?

Before you answer, I want you to consider some things.

I’m sorry to be such a downer

I’ve been thinking a lot about life insurance lately.

Recently, I found out a colleague I went to college with died in her sleep in her early 40s. She leaves behind a husband and two young children, all of whom I’m sure will miss her beyond belief.

I don’t know how much life insurance, if any, she had — and I honestly hope it was an astronomical sum — but friends quickly set up a GoFundMe to raise $20,000 for the family.

Look, $20,000 is a tidy sum, and it may help a great deal in bridging the immediate loss from a financial standpoint. But it’s a not a solution; it’s a bandage.

Last week, someone else I know was hospitalized with a fairly serious condition. It came suddenly, with no warning. Until it struck, he was as healthy as could be. Thankfully, he should make a full recovery.

You don’t have to read a local newspaper for long to see story after story of lives cut short by one tragedy or another. That’s the beginning of the story — not the end of it.

The best plan is to actually plan

Insurance is one of the few things we buy that we don’t actually want to need. I would be happy to never, ever, ever have to use any homeowners insurance, auto insurance, or disability insurance. I would gladly pay double what I’m paying for those if it came with a guarantee nothing would befall me that would require using them.

Life insurance is like that, too. Except you could go through life never getting into a car accident, but you’re not getting out of life alive.

Your survivors may not need your life insurance at the time of your death, or it could be the thing that keeps everything else from capsizing in the wake of it. Stop and think about what you’re doing with it.

Many people get nominal life insurance through their employer, maybe a year’s salary or something like that, and call it good.

“Do you have life insurance?” Yep, got it through work. Check that box.

Those who get an additional policy often get a 10- or 20-year term that not only reflected their earnings at the time of purchase, but also reflected their financial situation at the time.

Not many of us review our life insurance with the notion our families might actually need it. That mean’s we’re dead. That’s not a pleasant thought.

But it’s a critical piece of our financial plan.

How to think about life insurance

The purpose of life insurance is, at a minimum, to replace our financial contribution to our family for a specified period of time. Personally, I like 10 years as a minimum. That’s a long runway for my family to ride until something has to change.

Think about your own life, though.

If you’re a stay-at-home parent, how expensive is daycare if your spouse needs to put the kids somewhere to continue to work while you’re gone? Can the family stay in the same home, or will a move be necessary? What other contributions do you make that will require hiring out?

If you’re the breadwinner of the family, how much does your spouse need to survive without your paycheck? How will he or she pay for health insurance? Is there a 401(k) match that will no longer be there? What other benefits must be replaced?

If you’re a dual-income family, what will happen if you’re no longer bringing in that money? What does it do to the financial future? What stress does it put on paying down existing debt? Can your current lifestyle be funded with just one income?

This isn’t just a checkbox. It’s a real problem that people in every community face every single day.

What does life look like for your survivors if you die, and where does it make sense for life insurance to pick up the slack?

How much and what kind should you get?

What follows are my thoughts on this only. This is an individual decision you should make after a discussion with your family and counsel from people who are in a position to help you with your individual financial situation.

I suggest getting a 20-year term life policy that covers 10 years of your income plus 3% annually for inflation.

If you make $50,000 today, that would equate to an $875,000 policy. If you were to opt for a 10-year term it would be a $650,000 policy.

Why?

First, you should lock in a favorable rate for as long as you can when you’re as young and healthy as possible. Don’t wait until you’ve got chronic health issues and are 40 pounds overweight in your late 30s to get the life insurance medical exam. Do it ASAP. You will never be sorry you did.

Second, you’re building in a hedge against inflation because you’re trying to replace the buying power your income has today. Maybe you take this policy out and die by the end of the year. In that case, your heirs get the whole thing upfront in today’s dollars and have the opportunity to invest it wisely and let it grow even more.

But if you don’t die until year 15 of a 20-year policy, you want to make sure that amount reflects the number needed to replace your income 15 years from now. Of course, this doesn’t even take into account normal career growth in the form of raises or promotions. That’s why you want to review your policy and financial situation every three to five years to see if you need a supplemental life policy to make up the gap between your original policy and your new financial reality.

Is whole life worth considering?

Whole life is an attractive option in very few situations. Its best use, frankly, is as a tax shelter for high-worth individuals looking to shield more money.

For most people, it’s not the right vehicle.

You have to ask yourself what you’re trying to do. In the case of life insurance, you’re trying to protect your estate and heirs from suffering hardship due to your death. Unless you’re looking for a tax shelter, that is the only reason you are purchasing life insurance.

Purchasing a whole life policy, or a hybrid whole-term policy, that equates to the numbers I talked about earlier is prohibitively expensive. Several hundred to possibly thousands of dollars a month expensive.

Whole life complicates matters by tying an investment component in with the insurance. Typically, the investment portion forces you into options with higher fees and lower returns than you would get in the investment-specific world.

There’s also the notion of the cash value portion of whole life that you can borrow against. Yes, you can, and if you read the policy documentation you’ll see that when you borrow that money it will be at a percentage of interest typically higher than if you were to just go to the bank and get a loan.

Again, unless you’re a high-worth individual looking for tax advantages after you’ve maxed out all the traditional avenues, you’re best served finding an inexpensive term life policy that will protect your family and your assets in the event of your death. Leave the investing and borrowing aspects to a more appropriate vehicle.

What are you waiting for?

Buying the right amount of life insurance is the most important action you can take. It’s more important than optimizing your 401(k) investments, or reducing your tax burden, or slashing your grocery bill. It’s more important than maxing out your Roth IRA, or cutting fees, or eliminating cable.

You can do all of those things today, and if you die tomorrow none of it will hold a candle to the value a proper life insurance policy will bring.

I hope when you get to the end of that 20-year policy that you find yourself financially independent, debt free, and no longer in need of the insurance. It’ll be 20 years of the best money you ever spent for nothing.