Pursuing financial independence is quite the non-traditional path, so it necessitates some differences in financial planning from what most other people are doing. Life insurance is yet another one of those areas.
Why get life insurance?
The most basic purpose of insurance is to protect against a particular potential risk being realized. In the case of life insurance it is to protect against the early and unexpected death of someone who has dependents who rely partially or wholly on their income.
As such, single people with no children generally don’t need life insurance. Since I will be getting married next year it is responsible to look into life insurance coverage.
Term life insurance is generally the only type you should consider
FINRA identifies the five most common types of life insurance as:
- Term Life Insurance
- Whole Life Insurance
- Universal Life Insurance
- Variable Life Insurance
- Variable Universal Life Insurance
All of the latter four products are permanent policies, meaning that your policy does not expire: your heirs are guaranteed to receive a payout upon your death (as long as you continue to pay your premiums). Some of these policies feature a savings component wherein a portion of the premiums are deposited into a cash savings account, which can be withdrawn or loaned to the beneficiary while living.
Variable policies are actually more akin to financial securities than insurance. Companies offering these products must register them with the SEC, and they can only be sold by licensed brokers.
Term Life Insurance is called as such because it is not a permanent policy, and only lasts as long as you opt for; commonly terms are offered between 10 and 30 years, although five and 40 year policies can be found. It can be cancelled at any time if no longer needed or wanted. If you die within the term period, your beneficiaries get the payout amount they are obligated. If you outlast the TLI policy it expires with no value, though you can easily purchase a new one if desired (likely for a higher payment, as you will then be older). Term Life Insurance coverage is cheap and straightforward.
By contrast, many types of permanent policies are expensive and convoluted. For example, PolicyGenius estimated a Whole Life Insurance payment average of $437 per month for me, a healthy 29 year old male, to get a $500k policy. The truth is that Whole and Universal Life Insurance are products that are often sold by slick-talking salesmen to earn them commissions, and generate big profits for the insurance company. These products are borderline scams except in a very specific minority of fringe cases for complex estate planning.
Consider this: PolicyGenius also quotes me a 30 year $500k Term Life Insurance policy for an average of $45 per month. If I invest the difference between the whole and term policies — $392 per month — into an investment yielding a 5% annual real return, that results in $312.5k after 30 years. If I die during that time frame, my beneficiaries get $500k either way, but in addition with the term policy they also get whatever the invested monthly savings have amounted to by that point. If I’m alive in 30 years, I have an extra $312.5k to my name than I would have if I purchased whole life insurance.
Somewhat interestingly, for a healthy 29 year old male, saving and investing the difference between the cost of a $500k whole life policy versus a $500k 40 year term policy at a 5% annual real return is nearly the exact amount of time required for the savings to compound into enough money ($529k) to offset the entire cost of the coverage. Thus if I select the 40 year term policy and survive to age 69 I now have on hand the $500k the policy would have paid out — making whole life irrelevant — and if I die before then, the term policy pays out $500k to my beneficiaries.
The above of course ignores tax treatments, but it does demonstrate the massive amount of wealth drag created by permanent life insurance products like whole and universal life. The math shows that Term Life Insurance is absolutely the way to go!
Life insurance and financial independence: when to drop it
The interesting caveat of FIRE is that at some point, your assets provide enough passive income to sustain your family’s lifestyle and thus even if one partner died, the portfolio would presumably be inherited by the remaining family members where it would continue to provide this income.
This presents a different approach towards life insurance planning than those pursuing a traditional retirement, the vast majority of whom should be carrying life insurance at least until they are eligible to collect Social Security benefits, and many beyond that as well if both partners are drawing an income from Social Security and the loss of one of those checks would cause financial hardship for the surviving spouse.
If you have achieved financial independence and have a portfolio of at least 25 times your household’s annual expenses, it is likely no longer necessary to carry life insurance, as long as the household’s expenses will stay the same or go down upon the death of one partner. Make sure to factor in any expected cost increase in outsourcing household burden tasks (cleaning, maintenance, child care, etc.) if those cannot all be assumed by the surviving partner.
If you do need life insurance, how much coverage to purchase?
There are several different courses of action when determining how much term life insurance coverage to purchase, based on several different desired outcomes:
- Make your remaining family members immediately achieve FIRE upon your death (25-33x projected annual expenses, minus existing assets).
- Provide enough of an investment boost in present value to make your remaining family members achieve FIRE at your original goal ages.
- Provide only enough of an investment boost in present value to allow the surviving partner to retire comfortably at a standard retirement age.
- Accept the risk and skip any life insurance coverage to save a few hundred dollars per year.
The specific amount of coverage needed will depend on your existing assets, and may differ per partner if there is an income disparity. You’ll have to pull out that compound interest calculator and get to work. For investment growth projections, I always assume an average annual real return of 5%. Calculating based on an inflation-adjusted return additionally makes it easier since it puts future balances in present value terms which is useful for comparing against your expenses today.
The length of the term in years will also vary depending on your circumstances. For example, if you expect to achieve financial independence in ten years, then a ten year term life insurance policy is probably a great option. Try not to over-purchase a longer term or more coverage than you need — while you can always edit or cancel the plan later, the payments are averaged out over the term length, meaning you’re paying more than the market value of the plan in the early years, and less than the market value in the later years.
Also note that the amount of coverage that you require over time will change as your assets grow. For example if you are $1.5M away from your FIRE goal and expect to retire in 20 years, it doesn’t necessarily make sense to purchase a $1.5M 20 year term policy. It will almost certainly be cheaper to “ladder” multiple insurance policies, or to simply purchase a shorter term policy like ten years and re-evaluate your needs in the future when that policy gets close to expiration.
Personally, I settled on a 10 year $600k term policy. Added to our combined assets this would provide my fiancée with a large enough portfolio to be instantly financially independent at a low level of expenses, or after a few more years of accumulation would provide a stream of passive income for a comfortable early retirement. The ten year term also lines up nicely with my projected FIRE date, at which point I may no longer require life insurance.
Where to price out the options for term life insurance
I clicked onto a few marketplace sites and thought Quotacy was decent, if only for the fact that they don’t require you to enter contact information prior to viewing quotes like several of the other sites I investigated. They have a couple dozen different carriers and the quoted rates seem competitive, though it’s probably worth just heading to the insurance provider’s own site after getting your quote to compare.
For what it’s worth, a 10 year $600k policy from Lincoln Financial was quoted to me at $14.43 per month on Quotacy and when I called Lincoln Financial they quoted the exact same price. The guy did spend a minute trying to upsell me on a 30 or 35 year term policy but when I told him I had already calculated my coverage needs needs based on my current assets and expected future growth over time he dropped the pitch and said I sounded much more informed on my needs than his average client.
If you have not yet achieved FIRE and you have dependents or simply a committed partner working towards FI with you, then term life insurance is probably worth getting by following the guidance in this article. In general everyone should review their insurance coverage when they have changes in life circumstances such as marital status or the birth of a child. Those pursuing financial independence should additionally review if their coverage is still appropriate as they make progress towards their “FI number.” If your assets have grown faster than expected it may allow you to reduce your term life insurance coverage.