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Get the right amount of life insurance
Do you need it? How much? What kind?
By Walter Updegrave, MONEY Magazine senior editor
July 11 2006: 11:16 AM EDT


NEW YORK (MONEY) — QUESTION: My husband and I own our home, plus we have two rental homes and two investment homes that are now for sale. My husband recently cashed out his whole life policy and ended up with around $6,000. Given the assets we own and the fact that we have a $250,000 line of credit, my husband feels we don’t need life insurance any longer, so he also wants to terminate my policy. I think we still ought to have term life insurance, however, as we have seven children, three of which are still at home. Who do you think is right, me or my husband? – Cindy, Tempe, Arizona

ANSWER: I can’t say definitively who is right on the basis of the facts you’ve given me. What I can do, though, is suggest the sort of thought process you and your husband ought to go through.

The single most important reason to own life insurance is to provide support for your dependents should you or your husband die prematurely. The idea is to allow surviving family members to maintain something close to the standard of living they enjoyed prior to you or your husband’s death.

So the question becomes how much life insurance do you need to manage this?

Clearly, part of the answer to that question lies in how much income you and your husband currently earn. Generally, the lower your income, the less you have to replace and the less life insurance you need.

Factoring in a stay-at-home spouse Some people mistakenly assume that if a spouse doesn’t work outside the home then that spouse doesn’t need life insurance because there’s no salary to replace.

That thinking is wrong, however. A stay-at-home spouse does all sorts of things that would still need to be done. Either the surviving spouse would have to quit his or her job, spend less time at it, or hire someone to do much of this work.

In any case, from a purely financial point of view, a spouse who stays at home to raise the family does generate the equivalent of a salary and that needs to be taken into account.

Consider time frames You’ve also got to consider how long you’ll need to replace the income of a deceased spouse. You mention you still have three kids at home. If they’re toddlers, then you’ve got many years you’ll have to cover their expenses before they can get by on their own.

If they’re in college, however, then it should only be a few years before they can support themselves for the most part. (If your four children who’ve already left home are old enough to be financially independent, then they really aren’t a factor in deciding how much insurance you need.)

Consider other safety nets Finally, you need to consider what assets, such as investments, you can rely on to generate income. You mention you have two rental homes. Could they generate enough free cash flow after expenses (mortgage payments, real estate taxes, maintenance, etc.) to support your family if you or your husband weren’t around?

How about the two investment homes that are on the market? Would the sale proceeds sensibly invested generate enough income to support the remaining family members?

Perhaps a combination of the rental houses and the sale proceeds would generate enough income so that you don’t even need life insurance (in which case your husband would be right).

How much? What kind?

The point, though, is that unless you do this sort of analysis – what in life insurance circles is known as a “needs analysis” – you can’t really know for sure. Which means you could be subjecting your family to a big financial risk should you or your husband die. Or you could be spending money on insurance you don’t really need.

Fortunately, doing a needs analysis isn’t all that complicated. There are a number of online calculators that will crunch the numbers for you.

Or, if you’re uncomfortable doing that yourself, there are thousands of life insurance agents who will be only too happy to oblige.

If after doing a needs analysis, you find you do need insurance, then the question becomes which type.

There are two basic types of life policies: cash-value policies, which cover you for your entire life and include an investment component; and term policies, which cover you for a specific period of time and provide a death benefit only.

You can learn more about the differences between these two types of policies and when one might be more appropriate than the other by reading our MONEY 101 lesson on life insurance.

For most people the choice is a no-brainer. The premiums on a term policy are so much lower that it’s usually the only way they can afford to get anywhere close to the amount of insurance they need and still have money left over to do things like cover living expenses and save for retirement.

So you and your husband should stop this debate and do a needs analysis. And remember, whoever ends up being right on the insurance question, the real winner will be your family, whose financial security is really what matters here.