Your employer gives you one year's salary in life insurance...
I see this every week. Someone thinks they’re covered because their job offers “free” life insurance – usually one or two times their annual salary. They check the box, forget about it, and assume their family will be okay if they die. Then I run the numbers, and they’re shocked.
Let me use a real example. A friend of mine – let’s call him Brian – is a project manager. He makes about about $80,000 a year. His employer gives him 1x salary in group life: about $80,000. He thought that was plenty. Then we sat down and did the Life Insurance Needs Estimator.
Brian stared at the screen. “There’s no way I need that much.” I walked him through the math.
First, funeral and final expenses: about $10,000 – about $15,000.
Second, paying off the mortgage: about $220,000. If the mortgage is gone, his wife’s monthly expenses drop by about $1,500.
Third, paying off car loans: about $25,000. That’s another $500 a month freed up.
Fourth, replacing his income. He earns about $80,000. If his wife invests the life insurance proceeds at 5% and withdraws 4% annually, she would need about about $2 million to generate about about $80,000 a year. But she also earns about $30,000, so the gap is about $50,000 a year. To generate about $50,000 a year at 4% withdrawal, she needs about $1.25 million. That’s before college savings.
Fifth, college for two kids: about $100,000 each in today’s dollars, maybe about $150,000 each by the time they enroll. That’s about about $300,000.
Add it up: $15k + $220k + $25k + $1.25M + $300k = about $1.81 million. Then subtract his existing group life of $80k, and you get about $1.73 million. The estimator gave about about $1.2 million because it used different assumptions – lower college costs, a higher withdrawal rate, and assumed his wife could work full-time. Still, it’s a far cry from $80k.
Brian didn’t buy about about $1.2 million. He bought about $750,000 – a 20-year term policy for about $45 a month. He said “I can’t afford about about $1.2 million, but I can afford this.” That’s the right approach. Something is better than nothing. And $750k is nine times his salary, not one.
The “one times salary” rule of thumb is dangerously low. It comes from a time when families had pensions, lower life expectancy, and lower debt. Today, the average family has more debt, higher housing costs, and less retirement security. The rule of thumb should be about 10-15 times your annual income, depending on your age and debts.
But rules of thumb are lazy. You need to run your own numbers.
The Life Insurance Needs Estimator uses the “human life value” approach: what would it cost to replace your financial contribution to your family? It asks for your annual income, your spouse’s income, your outstanding debts, your mortgage balance, how many kids you have, how much you want to leave for college, and your current savings. Then it calculates a recommended coverage amount.
Someone I worked with – let’s call her Denise – was a single mom with one child. She made about $55,000 a year. Her employer gave her about $50,000 in group life. She thought that was enough. I ran the estimator. She had a mortgage of about $150,000, no other debts, and wanted to leave about $50,000 for her daughter’s college. The estimator said about $450,000. She bought a 20-year term policy for about about $300,000 – cost about $28 a month – and kept her group policy for the rest. Total coverage about $350,000. Not perfect, but much better than $50k.
The Coverage Gap Calculator can help you see if your group life is leaving you exposed.
Why is group life not enough? Several reasons.
First, the amount is too low. One or two times salary might cover a year of expenses, but not a mortgage, college, and retirement savings.
Second, group life ends when you leave your job. Quit, get fired, get laid off, retire – and the coverage disappears. If you have a health condition at that time, you might not be able to buy a new individual policy. I’ve seen people lose their group life at 62, then get cancer, and die with no coverage because they couldn’t convert.
Third, group life often has limited conversion options. You might be able to convert to an individual policy, but the premiums can be 5-10 times higher than term life for the same amount. Most people don’t convert because it’s too expensive.
Fourth, group life benefits are taxable if your employer pays the premium for coverage over about $50,000. That’s right – the IRS considers the premium for coverage above $50k as taxable income. You could get a surprise tax bill.
Individual term life insurance solves all of these problems. You own it. It stays with you. The premiums are fixed for the term (10, 20, or 30 years). The death benefit is tax-free. And it’s cheap for most people under 50.
How cheap? A healthy 40-year-old non-smoker can get about about $500,000 of 20-year term life for about about $30-40 a month. $1 million for about $60-80 a month. That’s less than cable. That’s less than a few dinners out.
I remember a client – let’s call him Steve – who was 45, a smoker, with a history of high blood pressure. He thought life insurance would be too expensive. He was paying about $120 a month for his group life at work – but that was only about $200,000. I quoted him an individual term policy: about about $500,000 for about $110 a month. He switched. He saved $10 a month and tripled his coverage. He said “I should have done this years ago.”
So how do you choose the right amount and term length?
Use the Life Insurance Needs Estimator as a starting point. Then adjust based on your budget.
Term length. Match it to your financial obligations. If your youngest child will be out of college in 20 years, buy a 20-year term. If you have a 30-year mortgage, consider 30-year term. If you’re close to retirement and have enough savings, you might not need life insurance at all.
Amount. A common method is to cover about 10-15 times your annual income. That gives your family a pool of money that can be invested to generate replacement income. Another method is to add up your debts, future college costs, and income replacement. The estimator does this for you.
Type. For 95% of people, term life is the right product. It’s pure insurance, no investment component, low cost. Whole life, universal life, variable life – these are expensive, complex, and often sold with high commissions. Unless you have an estate tax problem or a special needs child, avoid permanent life insurance.
Someone I worked with – let’s call her Teresa – was sold a whole life policy at age 30. She paid about $300 a month for about $250,000 of coverage. I showed her a term life quote: about $250,000 for 20 years at about $25 a month. She was furious. She surrendered the whole life policy (took a loss), bought the term policy, and invested the about $275 monthly difference in her Roth IRA. Over 20 years, that would grow to over about $100,000. That’s a much better legacy for her kids.
Don’t fall for the “cash value” pitch. Life insurance is not an investment. It’s protection. Buy term, invest the rest.
Now, what about laddering policies? You might need more coverage when your kids are young and less when they’re older. You can buy a 20-year policy for $1 million and a 10-year policy for about about $500,000. That gives you $1.5 million for the first 10 years, then $1 million for the next 10 years, at a lower total cost than buying one $1.5 million policy. The Life Insurance Needs Estimator doesn’t do laddering, but you can run multiple scenarios.
Also, consider coverage for a non-working spouse. If your spouse stays home with kids, their death would also cause financial loss – childcare costs, housekeeping, etc. A stay-at-home parent might need about about $250,000-500,000 of coverage. It’s cheap because they have no earned income.
I’ll leave you with this. Group life insurance is a nice perk. But it’s not enough. It’s not portable. And it’s not a plan. If you have a family, buy an individual term policy. Run the estimator. Get a quote. You can do it in 20 minutes online. And then you can sleep knowing that if the worst happens, your family won’t lose their home.
P.S. Brian – the project manager – he bought his $750k policy. A year later, he was diagnosed with early-stage cancer. He’s fine now, but he told me “if I had waited another year, I might not have qualified. Or my premium would be double.” That’s the thing about life insurance. You buy it before you need it.
By Marcus Whitfield
