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How Much Life Insurance Do You Need?

I just finished the book Spend ‘til the End by economist Laurence Kotlikoff and columnist Scott Burns (see my July 3 Yahoo!Finance column for a review). Among other areas, the book explores some of the myths and realities about life insurance.

Kotlikoff’s research finds almost no logical relationship between the amount of insurance people need and the amount they have. One study he co-authored based on the Survey of Consumer Finances found couples age 30 needed a median of 12.6 years of income in life insurance. On average, they had just over a year. 

Insufficient insurance is the primary cause of poverty among widows. According to the authors, roughly one-third of secondary-earning spouses are drastically underinsured. Secondary-earning spouses between the ages of 22 and 39 comprise the biggest underinsured group. 

This obviously doesn’t have to be the case, because a 20-year level term policy is really cheap these days. The average non-smoking healthy person in their 30s or 40s can get $1 million in coverage for $1 to $2 a day, according to Denise Mancini of Accuquote.com. (Like Kotlikoff, this is the only kind of life insurance I recommend. The complex whole life products involve too many fees and mediocre investment returns.) 

How much coverage do you need? At minimum, take your annual household income, add your existing debt payments, and then multiply by the number of years left until your kids finish college. But this is pretty simplistic, because people’s needs vary depending on whether both spouses work, what kind of savings you have and whether others can lend support (maybe you’re lucky enough to have grandma and gramps paying for your kids’ college). Try out the insurance needs calculator at accuquote.com. Kotlikoff sells software called ESPlanner that does the math in detail. 

Kotlikoff points out that people with kids may need less insurance than they realize, because the kids receive Social Security children’s survivor benefits. Moreover, the less you earn, the lower your insurance needs as you get into your 60s, because Social Security retirement and survivor benefits replace a much larger percentage of your pre-retirement or pre-widowhood (or widower-hood) compared to people who are wealthy.     

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