Be Responsible, Be Insured
A vanilla discussion, but crucial, nonetheless. Insurance is counterintuitive and often misunderstood. Those without disposable income are the first to pass on insurance coverage, when in reality, they should purchase the most. Similarly, as one accumulates wealth, it’s buying power and compounding effects are enough to reduce or eliminate many types of insurance.
Young couples with student loan debt, a mortgage, and two youngsters running around should prioritize quality insurance. As a young CRNA or other high-income earner, it’s essential to see that income every month. If something happens to that income stream, big trouble peeks it head from just beyond the horizon.
Lenders demand payment each month. They don’t care about your circumstances. Insurance may just save a bad experience from becoming worse.
On the flip side, my newly retired parents, still carry life insurance. If one of them passed, the life insurance payout would make zero difference. They have likely double their FI number.
No change in standard of living. No debt to pay off. No kids to support. A nest egg previously supporting both would now only support one. The financial value of the policy is peace of mind, but meaningless in the bigger picture.
Everyone finds themselves in vastly different situations, so I’ll keep this blog post to considerations and general recommendations.
Disclaimer: I acknowledge the sadness/heartbreak/despair/etc. associated with the passing of a loved one. This discussion is limited to financial implications.
Life Insurance
There are two primary forms of life insurance, term and whole life. Let’s start with term because it’s better.
Term Insurance
Pay a premium to receive a death benefit. The death benefit will be paid provided the premiums are current. Pretty intuitive. Premiums are cheap and usually fixed for the term. As the name suggests, policies are purchased for a term, generally 20 or 30 years. After this time, one can extend or renew coverage, but at a new (higher) premium appropriate for their age and health.
Expect a medical examination because the company want to know how long you are likely to live. Remember, insurance companies are in it to make money, not out of the goodness of their heart.
A young person may secure a $500,000 policy for as little as $20-30 per month. Premiums increase as the death benefit increases or if that wellness exam shows health complications or activities such as tobacco breathing treatments.
How much coverage do I need?
The boring answer is 10x annual income. That works, but for high-opportunity cost professionals, but we have more considerations.
I am admittedly questionably underinsured at this point in my life. My wife and I both make good money. No kids. Only mortgage debt which could be paid off by liquidating investments. We could each support a family on one income.
And 10x our annual income would be mid 7-figures. Sounds funny to read aloud. That’s 2-3x FI (financial independence) for us. Realistically, we don’t need life insurance at this point.
Because I love examples, lets throw another one out there:
35-year-old recently graduated CRNA with two kids. Now we are talking about the importance of insurance. My wife and I are hypothetically injecting ourselves into this scenario.
My hypothetical considerations as the new CRNA include:
$300K Mortgage
$200K Student loan debt
$50K Vehicle debt
$10K Credit card debt
$250K Per child
$200K Annual income Replacement
I think to myself, “If I die, how much will I need to pay off all debt, pay child expenses until age 18, and compensate for lost income?”
There is $560,000 in debt on the table that needs to be cleaned up. Plus, another $500,000 to cover both kids until they are 18 years old, assuming they are infants or toddlers. Right there I need over $1M of coverage. Because this situation includes vehicle and credit card debt, I assume there is not a significant emergency fund or brokerage account. Broke from school living paycheck to paycheck.
I need to replace my average CRNA gross income of $200,000. Depending on what my wife makes, coverage will vary. If she is a CRNA also earning $200,000, we have some wiggle room. If she stays at home with the kids and we are a 1 income household, no worries, we just need to consider cost of living.
Because we used average CRNA income for me, let’s assume national average income of $50,000 for my wife. I would feel comfortable replacing income to the point where kids are in school. That would allow my wife to take time off while kids are home and consider returning to the workforce once their days are filled with class and after-school activities.
We can assume 5ish years of income replacement. 5 years of my gross salary is $1M. That brings us to a $2M death benefit, which is approximately 10x MY annual income.
She can pay off all debt and invest the remaining death benefit to offset living expenses. She won’t need all 5 years of replacement income immediately. She won’t need the $500,000 for the kids immediately. Invest the remaining death benefit wisely to ensure it’s there as the years pass.
My wife wouldn’t need to carry this much because my $200,000 income is plenty strong to cover costs. I would recommend $500,000-1M for her. Term is cheap. Have peace of mind.
Wife is also a high-income earner – less coverage. Kids are 16 and 18 – less coverage. Already financially independent – less coverage.
More debt – more coverage. Want to cover kids’ college – more coverage. Spouse bad with money – more coverage won’t help.
It’s tough to know how loss of a loved one will affect anyone. I pretend my wife will miss me and mourn my death, but the jury is out. Morbid to know I will be worth more dead than alive for a period. And I’m ok with that. Mrs. TheFinancialCocktail will outlive me so it won’t be my problem.
Whole Life Insurance
Aka traditional, permanent, universal, indexed universal, variable universal. They all mean the same thing – scam. There are nuances to the aforementioned list of permanent life insurances, but here is the quick and dirty.
Whole life is similar to term insurance because there is a monthly premium and a death benefit. That’s about where the similarities end.
Whole life is life insurance for your entire life, not a limited term. So, policies can be purchased for newborns. If at any point in time the premium is not paid, the coverage is gone.
Premiums are high and fixed. The premium is split three ways. One part towards fees, one part towards the death benefit, and one part towards the cash value of the policy.
Think of the cash value as a savings account. Pay extra to increase the cash value. This cash account typically goes into some kind of fixed income investment looking at 3% annual growth, which is tax free. One can withdraw or take a loan from the “cash value” of the policy.
Despite premiums being fixed, a greater portion of the premium is allocated towards the death benefit as you age. You don’t get a higher payout despite more of the premium going towards the death benefit; the insurance company just keeps more of your premium. Again, they are in it to make $$, not out of the goodness of their heart.
So, what makes this a scam? Oh boy, here we go.
The premiums are high. Such high. I’m talking Chinese weather balloon high. To get the same death benefit as term, expect just over 20x the cost of term. Just let that marinade a hot minute.
So that $2M death benefit costing approximately $80-100 per month would run you close to $2,000 monthly. Yes, but the cash value…
During the first 2-5 years of a policy, cash value doesn’t begin to accrue. “I’m glad my 401(k) and personal brokerages aren’t like that,” he said facetiously. And when cash value begins to accrue, the investment return is poor. It’s typically invested in annuities and bonds, which underperform inflation. And you pay high fees the entire time.
But you can use the cash value to pay for cost of living or make a big purchase. True. There are ways to do this but remember – ONE there are fees associated with pretty much everything. TWO, it’s your money that YOU put in there. THREE, dropping the policy won’t get you the entire cash value, but rather the surrender value (cash value minus fees).
Eventually, it’s too expensive to leave. Just take the surrender value and get out.
Oh, and the company keeps the cash value upon death. They count the cash value towards the death benefit.
$1M death benefit + $500,000 cash value = $1M payout upon death
They say, “Thanks for investing with us. We will give you the death benefit, but we actually keep your investment account that you have paid into for decades to offset our losses.”
-End Rant-
Buy term. Invest the difference in your favorite brokerage or retirement account. You are welcome. If you are looking to donate money, consider literally anywhere aside from whole life companies. Even a good ol Benjamin bonfire is a better option.
Health Insurance
You need it. Cost and coverage is dependent on so many factors. It’s expensive, but necessary. Ah, the struggles of having to pay for health insurance because you make money (aside from the military route). Rough.
Kaiser Family Foundation estimates the average employer sponsored plan runs just over $5,500 for an annual family plan and $1,200 for an individual.
Super quick overview:
Health Maintenance Organization (HMO)
Must stay in-network to have coverage. There is typically a premium, deductible, and minimal copay. Need a referral for a specialist.
Preferred Provider Organization (PPO)
More provider options vs HMO, but that comes with higher out-of-pocket costs. They have a premium, deductible (usually), and minimal copay. Going out-of-network may cost a bit more, but insurance will still cover some of it.
Exclusive Provider Organization (EPO)
More flexibility for provider selection than an HMO, but no out-of-network coverage. They have a premium, deductible (usually) and minimal copay.
Catastrophic Plan
For the healthy under 30 crowd. Low premiums and free preventative care. Basically, has a high deductible around $10,000 for an individual. As the name suggests, covers catastrophes and that’s about it.
High Deductible Health Plan (HDHP)
This is what I use because I am reasonably healthy and have access to a health savings account (HSA). Greatest tax efficient vehicle available. Network coverage varies. The premiums are low, but the deductibles are…you guessed it…high. Copays are variable.
COBRA Insurance
Consolidated Omnibus Budget Reconciliation Act. If you lose health benefits, you can stay with the group plan for a short while, typically up to 18 months. The fees are higher than when you were an employee, but better than nothing.
Marketplace
The wild west of insurance coverage. Lots of variability based on offerings. Typically used for the 1099 folks. It’s expensive. Cheaper health insurance is a benefit of being a W2 employee.
Medicare
Good ol Medicare. Federal health coverage for those 65 and older. This is a sore spot for those who do their own billing. And is undoubtedly political suicide for those even considering cutting back on this 21% piece of the national spending. I will remain publicly neutral about Medicare for concern someone will be upset and attempt to shut down this blog that tens of people read every week. And I thank you.
Dental and Vision
Read the numbers. Call around to see if it makes sense to add these on. Family, maybe. Individual, probably not. We pay out-of-pocket for dental and vision because it is cheaper. Brush and floss regularly to avoid extra dental work. And they sell prescription glasses and custom lenses online for reasonable prices.
Disability Insurance
The way to replace income if you are living, but unable to perform job duties. The more income you want to replace, the more expensive the premium. Intuitive. Yet another reason why grinding hard to achieve FI makes life more affordable. When you don’t need the insurance, you don’t have a premium.
There are employer plans and private companies that offer all sorts of policies with all sorts of fine print. Again, insurance companies aren’t your friend. Especially for disability coverage, which is subjective at times, they won’t pay out unless they absolutely must.
Short-term disability is typically limited to 6 months. This is where long-term disability usually starts. Short-term looks at you being able to do the same job. Long-term considers you being able to do your job OR ANY JOB. So they may be resistant to pay if you can work, but not give anesthesia.
Some maternity leave coverage falls under short term disability. This can be purchased through companies like Aflac.
Investopedia.com is consistent with other sites I read. They state most long-term policies replace 40-70% of your income and cost 1-3% of your annual salary.
Ideally, sign a policy guaranteeing income replacement. There may be a waiting period before receiving benefits such as 3 months. There may also be a maximum number of years one will receive benefits.
At $200,000 annually, look for somewhere between $8,000 and $10,000 per month. Expect to pay $300-400 monthly for this coverage.
Not a hard rule. All of these insurance premiums are starting to add up. Find the numbers that work for you.
So…insurance is pretty boring. And this is just an overview. It’s a prerequisite to being a responsible adult, spouse, parent, and family member.
Bottom line is the more money you have, the less insurance you need. All the more reason to live well below your means and reach FI. Then the stress of a massive medical bill or life-altering injury suck a little less. Stay well and hope to never use the insurance you purchased!
