Another note from AverageJoe’s Thanksgiving visit to the in-laws:

Dear blog diary,

I’ve just trounced my mother-in-law at Scrabble again. It was absolute luck that the triple word score was open for my play of “austerity.” Of course, I had to hide a U and Y in my sleeve to place a nine-letter score. Luckily, we’ve both had enough “holiday cheer” that she didn’t notice. I know that to be a good son-in-law I should let her win, but not until I get a chance to play the word “bailout.”

Between all this winning and making Rice Krispies Turkey Pop Treats, I totally can’t be bothered to post anything today. Instead, I’ve opened the basement and let out The Other Guy, so named because he’s still a practicing financial advisor and doesn’t understand that being associated with me would totally be good for business. Whatever.

We’ll have a special piece tomorrow, but will completely understand if you don’t have time to read it. Safe travels, everyone!

Now, on to the Other Guy:

A couple of weeks ago, after being sick for about 10 days, I finally went to the doctor. Apparently, I have ‘walking pneumonia.’ I told the doctor that I don’t do any physical exercise, including walking, so I couldn’t possibly have “walking” anything.

In any event, I didn’t feel well. I began to contemplate my own mortality and then an idea popped in my mind: let’s spend a couple of days talking about life insurance! It’s obviously everyone’s favorite topic…and as a financial advisor who doesn’t like to be sold some insurance, I make the perfect teacher. As AverageJoe did with the “evaluate a mutual fund in 10 minutes” post, I’m going to break it down nice and easy for ya’.

Here goes:

Before anything, let’s not waste time evaluating coverages if we don’t have to. All too often, insurance sales professionals and financial advisors will just make the assumption that you need it and proceed to sell it to you. Here’s an easy way to determine if you need life insurance at all:

Questions to ask:

Does anyone rely on you for financial support, either right this moment or if you got hit by lightning?

If you’re single and/or have no dependents, there’s almost a zero point zero percent chance that you need life insurance. I might be convinced that a small group policy so that someone can bury you is adequate. If you have charitable intentions, there are insurance strategies that work really well….but that’s all. Nothing more.

Don’t let an insurance salesman tell you otherwise.

For those of you who have people relying on you for financial support here’s an easy way to calculate how much you need. Is this the best way? Nope. However, once we walk through these steps you’ll be on your way to making a good insurance decision.

Every life insurance discussion contains assumptions. You’ll need to make some to decide what amount is right for you. At the least, you’ll need to know where assumptions have been made, so you’re able to change directions if you need to.

Here are a few assumptions:

If married, I usually assume with clients that they’ll want the mortgage paid off when they die. Even if both spouses have a full time job and can still afford the house, I’ve seen too many people “go off the deep end” when their spouse dies to determine whether everything will remain stable at work and home. I can understand leaving this out, but at the least I’d evaluate your insurance cost with and without this cost before deciding to drop it.

You may find the additional cost is worth the pain.

If you have children, I assume you’ll want them to go to college, and you’ll want it paid for . Maybe not Harvard or Yale, but you want them to have some level of in-state public university education. Since college costs increase 8-10 percent per year on average, this is one of the most expensive budget items a family can face.

Let’s have the discussion here that we’ll have in client meetings: Maybe you paid for your own college expenses. Evaluate your children and savings and not your personal situation when you went to school. With costs rising quickly, do you want them to have this burden?

Here’s how much life insurance you’ll need…plus or minus the assumptions above plus a few more below.

Add together all of your debts, including your mortgage: $__________________

I’ve done the math on an average in-state tuition in the chart below. Add in these costs: $__________________

Next, we’re going to give your family basic income to live on. Here are where we need to make some large assumptions. Take your annual post tax (take home) income and multiply by 80%. This assumes that your family will live on 80 percent of your current salary if you’ve died. There are better ways to do this. Instead, determine what percent your family would need in the event of your death and use that percentage.

Divide this amount by .05. This means that you’ll need to peel off 5 percent to live on. This single number creates (again) huge assumptions. The biggest? It’s that you’ll continue to live on this income stream even as inflation skyrockets. Once again, we’re trying to get in the ballpark, so if you’re trying to do this the “quick and dirty” way, we’ll be close, but there are better ways.

Place your answer here: $__________________

Add up these 3 lines, that’s how much you need.
$__________________

Now, often, I’ve seen insurance salespeople stop at this point. Not good. Remember, you have some current savings! The goal of insurance in most situations is to replace income that you don’t yet have.

Subtract the amount of money you already have saved from the final number.

$__________________
Buy the difference.

Education Chart

Later, we’ll have a discussion on the various types of insurance you should consider and the #1 question you should ask before you buy anything from any insurance sales person.

As always, this exercise is more about understanding the variables that go into making a good decision as much as it is about the final product. Plug in your own unique situation and evaluate many types of coverage thoroughly before buying life insurance.